Retrospective IHT planning

Beneficiaries can vary the terms of the will they are inheriting, but how can they ensure it’s done tax efficiently?

Retrospective IHT planning

Deeds of variation (DOV) allow the beneficiaries of a will to change its terms. Although they have other applications, they’re most commonly used for IHT planning. A DOV can be made provided the property received under the will hasn’t been sold or given away by the beneficiaries. You have two years from the date of death in which to make a variation.

Example. Martin dies at the age 68 leaving his second home worth £400,000 to his children, Janet and John. The rest of his estate, worth £450,000, is left to his wife. At current rates the estate would owe IHT of around £30,000 on the children’s legacy. The balance is exempt from IHT as it’s covered by the spousal gift exemption. Martin’s widow and children decide to make a DOV to the effect that she gets a quarter share of the property, and Janet and John the remainder. Now there will be no IHT liability. As a result of using a DOV they saved £30,000 tax.

Tip. Make sure the DOV is signed by all the beneficiaries of the will, otherwise it won’t be effective. The DOV is a legal document so unless you’re certain you can draw this up yourself, we would recommend you ask a solicitor to do it.

Consideration trap

In the case of Lau v HMRC , Mrs Lau (L) gave £1 million to her son. Previously, he had given up a legacy of £665,000 from his step-father on which some IHT was payable. Under the terms of the DOV all the money went to L and so was IHT exempt because it was now a gift between spouses. L claimed the subsequent gift to her son wasn’t connected to him giving up his legacy under the will. But the Special Commissioner hearing the case decided that the evidence clearly showed one was made in return for the other. Therefore, because the arrangement involved monetary consideration, s.142(3) of the Inheritance Tax Act 1984 cancelled the tax benefit.

Tip. A genuine gift by one beneficiary of a will to another following a DOV will not cause the tax benefit to be lost. But proof would be needed that the DOV and the later gift were not connected. This can be difficult to show. Therefore, the longer the gap between the two transactions the better.

Trap. When using a DOV for IHT planning, an agreement to financially compensate a beneficiary for giving up their legacy could result in the IHT advantage being lost. Nevertheless, the terms of the DOV would be binding and this can lead to administrative problems and expense in reversing its terms. However, there’s a simple way to avoid this problem.

Uncertainty clause

In another case, The Personal Representatives of Mrs Gwendoline Glowacki (Deceased) , the DOV included an “uncertainty clause”. It said that if the DOV became ineffective for IHT purposes as a result of a challenge by the Taxman, then the whole deed would be void. We recommend all DOVs should include this type of clause.

If you would like more information or advice on Inheritance Tax, please don't hesitate to contact us.

Retrospective IHT planning

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