You may have seen first-hand how busy the property market has been in the last year, as clients buy and sell homes to take advantage of the Stamp Duty holiday.
Introduced by chancellor Rishi Sunak to boost the housing market in 2020, it prompted a level of activity that has helped drive up demand – and therefore prices – dramatically. So much so, that according to the Office for National Statistics (ONS) average house prices increased by 8.6% over the year to February 2021.
One Guardian article shares data from the Nationwide Building Society, which shows the average price of a UK home rose by 0.7% in February 2021, taking the average price up to £231,068 – the highest on record.
The graph below from the Nationwide Building Society provides a striking illustration of how sharp the rise in average UK property prices has been since 2018.
Source: The Guardian
This means that some of your clients may have enjoyed something of a windfall if they have downsized their property or sold a second home.
However, having that extra cash may have left clients wondering how best to use it, and what the tax implications might be.
Read on to learn why your clients need to consider “inflation-proofing” their windfall, and potentially shield it from future taxation.
1. Keeping the money in cash accounts may cost them in the long term
The Bank of England (BoE) base rate still stands at the historically low rate of 0.1%. In addition, in early 2021 the BoE told high street lenders to prepare for negative interest rates, although it stressed that it did not see another base rate cut as a certainty.
Even the likes of National Savings & Investments (NS&I), which many savers saw as a haven when other banks slashed their rates, reduced its rates. Its Income Bond account, for example, has dropped from 1.16% to 0.01%.
Low interest can be depressing enough, but the risk it presents to client’s equity in real terms comes from the possible impact of inflation.
Inflation is the rate at which the prices of goods and services increase, and currently stands at 0.7%. This means the cost of living is outstripping the interest being paid on savings accounts or on equity sat in cash accounts, effectively devaluing it in real terms.
While the graph below shows inflation is lower now than it has been in recent years, having breached 3% in 2018, there is now speculation that it could rise again. As the world returns to a post-Covid normal and demand for goods and services increases, so – some have claimed – could inflation.
Historically, higher inflation means higher interest rates, although at a time when many governments are grappling with large debt burden, the traditional trend may not happen.
With higher interest rates, debt-laden governments would see their repayments go up, meaning central banks may instead delay interest rate rises despite inflation increases – something that may impact on the real term value of any equity sitting in cash savings.
2. An option might be to “inflation-proof”the equity by exposing it to greater growth potential
Even when interest rates are higher, the long-term potential growth of investing might provide greater returns.
Despite 2020 seeing a major downturn at the beginning of the year, many markets recovered and even grew during the rest of the year.
The illustration below shows the performance of the main American equity indices between January 2020 and March 2021, highlighting levels of growth many may be surprised at.
It’s also easy to forget that before 2020 and the coronavirus pandemic, there had been one of the strongest market performances over a ten-year period between 2009 and 2019.
While investing must always been seen as a long-term venture and past performance is no guarantee of future performance, investing may allow your clients to shield any equity released from a property sale from inflation.
Speaking with a financial planner could help your clients understand the risks and potential rewards of investing, and any growth the equity may potentially be exposed to. This may mean they can leave more money to loved ones when they die.
3. Your client may be liable to Inheritance Tax (IHT)
Releasing equity from a property can result in large sums of money being received, which, in turn, could take your client above the tax-free amount they can have in their estate.
In 2021, the amount – known as the “nil-rate band” (NRB) – stands at £325,000 per person, or £650,000 for a married couple. Any assets over this amount are subject to an IHT tax charge, which is typically 40%.
Your clients may also benefit from the residence nil-rate band (RNRB) that provides an additional £175,000 per person. If they can claim it, the amount they can have in their estate before IHT rises to £500,000 for an individual, or £1 million for a married couple.
In some cases, your client may be able to downsize to a less valuable property and still claim RNRB on the original, more expensive house they sold under “downsizing addition” rules.
There are strict rules and regulations around the NRB, RNRB and downsizing addition, so professional advice should be sought.
4. Using gifts could reduce the amount in your client’s estate
If equity from a house sale does expose your client to IHT, they may be able to gift money to others to reduce the value of their estate. HMRC allows certain gifts to be made every tax year that include:
- £3,000 that can be split between however many people a client wishes, but the total gifts must not exceed this amount.
- Unlimited gifts of up to £250 to others.
- Clients can make wedding gifts to anyone up to £1,000. Wedding gifts can be made up to £2,500 to grandchildren or £5,000 to their children.
- Gifts of any size could fall outside of your client’s estate if they live for seven years after making it. This is known as a “Potentially Exempt Transfer”.
- Clients could make regular gifts of any amount as long as it is not from capital, and does not impact on their standard of living.
As the rules around gifting can be complicated, clients should speak to a financial planner to ensure it is right for them.
5. Business Relief (BR) could help reduce IHT exposure
If the equity released from a property purchase exposes your client to IHT, they may want to consider investments that provide BR. These effectively allow money to be passed to beneficiaries free of IHT, although the money must be invested for more than two years.
Investments with BR could help clients who:
- Want to retain access to their money
- Intend to cover the cost of later-life care
- Feel trusts are too expensive and/or complicated
- Believe their beneficiaries are too young to inherit the wealth.
Get in touch
If you would like to discuss ways to help your clients preserve equity released from a house sale, or the issue of any IHT liability those you work with may have, please email email@example.com or call 01904 655 330.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation which is subject to change.
Please note, this article only deals with England and our understanding of English Law.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.