Deeds of variation have been a common Inheritance Tax (IHT) planning
tool for many years. But following a change in
IHT rules, there are conflicting
views on whether they are worthwhile. What’s the answer?
What is a deed of variation?
Sometimes, the terms of a person’s will don’t meet the requirements of
the beneficiaries. Fortunately, there’s a way to rearrange these, provided
it’s done within two years of the date of death. It’s achieved by a
legal document called a deed of variation (DOV) (see The next step),
which must be signed by the beneficiaries. It allows them to decide how
the estate should be divided. So what are the benefits of using a DOV?
Gifts to spouses
The most common reason for using a DOV for IHT planning is to divert all or part of a spouse’s estate in favour of other beneficiaries so that the IHT nil-rate band (NRB) isn’t lost. The NRB is the amount of a person’s estate that
is taxable at 0%. Until 2007, when one spouse gifted all their estate to the other, their NRB was wasted as gifts between spouses are exempt from IHT. But from October 2007 any unused NRB when one spouse dies can be transferred to the other. This means that when the second spouse dies their own NRB is available plus any transferred from the first spouse. But does this mean that DOVs are now pointless?
Example part 1
In January 2010 Ruth dies leaving an estate worth £500,000. they have two adult sons. Rod dies some ten years later and his estate has grown to £1.5m (a growth rate of just under 5% per annum), while the NRB has been increased only at the rate of inflation, say, 3% per year. Therefore, IHT of £260,000 would be due, but this could be reduced by using a DOV.
Example part 2
A DOV could vary the terms of Ruth’s will so that an amount equal to the NRB, currently £325,000, went to her children, and the balance of her estate, £175,000, to Rod. Assuming the same conditions as in the previous example, the IHT due on rod’s estate when he dies would be £235,000, a saving of £25,000. It seems that a DOV can still save IHT.
Trap
The tax saving relies on the rate of growth in the value of the estate exceeding the rate of increase in the NRB. While historically this is often the case, there’s no guarantee; it depends on what the surviving spouse does with their money.
An alternative plan
If Ruth’s will isn’t subject to a DOV to make the £324,000 gift to the sons, Rod could make it out of his inheritance instead. Assuming the same circumstances as in the previous examples, the IHT payable when Rod dies would be £65,000. A much improved tax saving. This result is achieved because the gift by Rod becomes IHT exempt as he survives more than seven years from the time he made it.
Tip
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. This plan carries a risk if the second spouse fails to survive seven years as it will remain part of their estate for IHT purposes.
