Deeds of variation and retrospective IHT planning

A good deed

Wills are not always written with inheritance tax (IHT) planning in mind or the planning can be ineffective when the time comes. This can result in IHT bills that might easily have been avoided had the will been updated. The good news for the beneficiaries of a such a will is that they can reorganise the estate in a more tax-efficient way using a deed of variation. This can change how the estate is distributed between them which can also improve the tax outcome. As you would expect, there are conditions that must be met.

Conditions

To be effective, a deed of variation must:

• be made within two years of the deceased’s death
• be agreed to by all beneficiaries of the original will
• not be made in return for payment
• state that “s.142(1) Inheritance Tax Act 1984 and s.62(6) Taxation of Chargeable Gains Act 1992 are to apply” (see The next step ).

Example part 1. In November 2020 Rani died leaving an estate worth £500,000 to her husband Rajeev. This is an exempt transfer and means that Rani’s nil rate band (NRB) and residence nil rate band (RNRB) is transferred to Rajeev. His estate is also worth £500,000. Rajeev has two adult sons. He dies in 2023 by which time his estate has grown to £1.5m including a home worth £475,000. Assuming no IHT reliefs or exemptions apply the estate will owe £200,000 in IHT (£1,500,000 - (£325,000 x 2)) nil rate band and (£175,000 x 2 residence nil rate band).

Example part 2. A deed of variation could vary Rani’s will so that an amount equal to the NRB (£325,000) went to her children leaving the balance of her estate of £175,000 to Rajeev. Assuming the same rate of growth in the estate as in Example 1, the IHT on Rajeev’s estate when he dies would be £135,000, a saving of £65,000.

The saving is achieved because the growth in value of the £325,000 of Rani’s estate left to her children accrues to them instead of inflating Rajeev’s estate and increasing the IHT on that. However, even more IHT could be saved.

IHT plan B

If Rani’s will is left alone and no deed of variation is made so that the whole estate goes to Rajeev, he could make a gift of £325,000 out of his inheritance. Assuming the other circumstances are the same as in the previous examples, the IHT payable when Rajeev dies could be reduced to just £5,000.

There is a risk with plan B. To work Rajeev must survive seven years from the date of the £325,000 gift he makes to his sons. A realistic view of health and life expectancy should be made before deciding between using a deed of variation and plan B.

If you expect the surviving spouse to live more than another seven years, then allow the estate on the first death to pass to them, but immediately consider making a gift of some of it to the subsequent generations.