IHT-Solutions

2nd generation tax-planning and the Deed of Variation

I have often discussed the great benefits of utilising a Deed of Variation within 2 years of a death to save inheritance tax.

One ordinarily utilises the Deed of Variation (DOV) to ensure the use of a nil-rate band upon the first death of a spouse within a marriage.

The DOV can also be very useful in arranging the payment of a specific gift to a donee by the beneficiary named under a Will. The great benefit in this scenario is that the amended gift is treated as a gift by the deceased rather than the original beneficiary and as such there is no requirement to wait 7 years to make the gift tax-free.

One use of the Deed of Variation which is certainly becoming more prevalent in my experience is what I would call the 2nd generation tax-planning DOV.

By way of example, I would set out what is a fairly common scenario. An elderly person in their 80s has died and leaves a net estate of £400,000 after tax. The estate is divided equally between the two children of the deceased in their early 60s who are both homeowners with reasonable pension provisions in place.

Due to house price rises in recent years, both of the children of the deceased already have estates which are
worth substantially in excess of the IHT nil rate band. By virtue of their deceased parent's Will as stated above, they will now receive a further £200,000 into their estates which will potentially add a further £80,000 IHT liability (40% of £200,000) to their own estates.

The IHT solution is the Deed of Variation under which the parent's legacy can be directed away from the beneficiary child and instead placed into a discretionary trust which falls outside the estate of the surviving child. As the child can remain a potential beneficiary of the Trust created they can still benefit from the Trust whilst making sure that the legacy from their parents will not become taxable within their own estates.

As always, a suitably qualified professional adviser should always be employed to ensure that the documentation is correctly drawn up to ensure that you benefit from the potential tax savings.

The "magic" 2 years in which to save IHT

Whilst whether we like it or not, death is one of the few certainties in life, death in itself is not the final word when it comes to the saving of inheritance tax.

For up to 2 years after the date of death, beneficiaries of a Will or intestacy can gift their share of an estate to anyone or any organisation of their choosing without penalty, by virtue of what is known as a Deed of Variation. There are, of course, a number of reasons why Deeds of Variation are entered into, not the least being the saving of inheritance tax.

On a regular basis during my working life, I meet widows and widowers who are beneficiaries of simple Wills left by their deceased spouse leaving everything to them. Indeed, until 5 or 6 years ago, Wills of this type for the vast majority of married couples were very often highly suitable. As a result of the large increases in property prices over the last few years, many of these clients are now finding that the estate of the surviving spouse is now well in excess of the nil rate band of tax (currently £285,000). As a result, upon the death of the surviving spouse, there will be inheritance tax payable at a rate of 40% on any assets in excess of the nil-rate band. This will in many instances result in a tax liability upon the survivor's death in excess of £50,000.

This is where the Deed of Variation and the "magic" 2 years comes into play. Under the Deed of Variation it is possible to re-write a Will and even retrospectively sever a joint tenancy to ensure a property is held as tenants in common. Accordingly, the surviving spouse can set up the tax efficient nil rate band discretionary loan trust Will referred to in previous posts, even though their deceased spouse never changed their Will to this effect during their lifetime.

Of course, the right to make a Deed of Variation may be removed and as a result I would always advise clients to make an up to date professionally drawn Will. For the time being, however, the Deed of Variation in many cases gives an excellent escape route in the battle to save IHT.

How you can change a Will after death to save inheritance tax

Many families are caught in a classic "property rich" but "cash poor" situation. As such their property assets exceed by some way the current nil rate band of £285000 (2006/7) resulting in a liability of 40% tax on the balance over this sum but they have little in the way of liquid funds to alleviate the situation simply.

It is, of course, possible to prepare a suitably drawn professional Will to improve the situation but what happens if no such Will has been made by the date of death.

In my professional life, this is a situation that I encounter on a fairly regular basis and the good news is that at the time of writing the law allows the Will of the deceased to be re-written for a period of up to 2 years after the date of death by way of a Deed of Variation.

In simple terms this means that so long as the beneficiary(s) of the original Will are agreed on the variation, the original Will can effectively be re-written to make the estate tax effective. At the current time this can enable an inheritance tax saving of up to £114,000.00, which is not to be sneezed at. I intend to set out some working practical examples of the way in which a deed of variation can be implemented to save inheritance tax over the coming months.