Experts have advised on steps to take to limit inheritance tax liabilities (Image: Getty)
A financial expert has warned that the dream of paying off your mortgage might not be all it is made out to be. The dream of paying off a mortgage has long been an aspiration of millions of people, seen as a way of obtaining, at least in part, financial freedom.
In the pursuit of doing so, many people pay extra on their mortgage in a bid to realise their ambitions earlier in life, but doing so could have a significant impact on one’s inheritance tax liability. As more and more middle class or asset wealthy families get stung by the levy, labelled by some as a “death tax”, storing wealth in bricks and mortar could be leading to a higher burden for homeowners. David Little, financial planner at wealth management firm Evelyn Partners told the Telegraph: “Owning your home outright and being debt-free have long been seen as hallmarks of financial prudence and security.”
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A paid off mortgage can in some instances increase a tax liability (Image: Getty)
But he warned that rising house prices, combined with frozen tax thresholds — with the £325,000 nil-rate band unchanged since 2009 — could mean that estates once considered comfortably middle-class are now being hit with a 40% inheritance tax bill on death.
He added: “In affluent parts of the UK – particularly areas of London and the South East – property values alone, without any savings or investments, can easily exceed the combined inheritance tax allowances available to a couple.
“This means that homeowners who have diligently paid off their mortgage may inadvertently be increasing the value of the estate exposed to tax.”
Inheritance tax is currently charged at 40% on estates worth more than £325,000, although this threshold can rise to £500,000 when passing on a main residence to direct descendants. Despite this, thousands of families still face large tax bills each year.
Financial advisers point to the “seven-year rule” as a key strategy. This allows individuals to give away money or assets during their lifetime, with no inheritance tax to pay provided they survive for seven years after making the gift.
Gifts can include cash, property or valuable possessions, and there is no limit to how much can be given away under this rule.
However, if the person giving the gift dies within seven years, the amount may still be subject to tax on a sliding scale.
In addition to larger gifts, there are smaller allowances that can be used each year.
Ben Clapham, a financial planning director at Shackleton Advisers said: “Having accessible capital makes it easier to make gifts during your lifetime. Gifts that survive seven years fall outside the estate entirely, which is usually far more effective than relying on mortgage debt to reduce the property value.”
Individuals can give away up to £3,000 annually without it being added to the value of their estate. This is known as the annual exemption and can be carried forward one year if unused.