Deeds of Variation Can Reduce Inheritance Tax

When someone passes away, their will determines how their estate is distributed. But what happens if the will doesn’t suit the current needs of the beneficiaries or leads to an unnecessary inheritance tax (IHT) burden? This is where a deed of variation can play a powerful role.

A deed of variation—also called an instrument of variation—allows beneficiaries to change how a deceased person’s estate is distributed, even after death. When used correctly, this legal tool can reduce IHT liabilities and create a more tax-efficient outcome for families and loved ones.

What Is a Deed of Variation?

A deed of variation is a legally binding agreement that allows the beneficiaries of an estate to alter the terms of a will. This doesn’t rewrite the will itself but effectively changes how assets are distributed. Legally, it treats the new arrangement as though the deceased had made it in the original will.

This can be incredibly valuable for tax planning, especially where the original will does not take into account updated tax laws, changes in family dynamics, or where beneficiaries want to make more equitable or strategic arrangements.

Why Use a Deed of Variation?

There are several compelling reasons beneficiaries might choose to execute a deed of variation:

• To Reduce Inheritance Tax: Redirecting assets to a spouse, civil partner, or charity can take advantage of tax exemptions, potentially lowering or eliminating IHT liabilities.
• To Provide for Other Family Members: Sometimes, the will may exclude certain individuals, such as grandchildren or stepchildren. A deed of variation can help include them.
• To Achieve Fairer Distribution: Where circumstances have changed since the will was written, a variation can realign the estate to reflect the family’s current wishes and needs.
• To Facilitate Trust Planning: Variations can help set up discretionary trusts or other structures to protect wealth for future generations.

Legal Requirements for a Valid Deed of Variation

To ensure a deed of variation is effective and recognised for tax purposes, it must meet strict criteria:

1. Executed Within Two Years of Death: Timing is critical. The variation must be completed and signed within two years of the deceased’s date of death.
2. Must Be in Writing: A verbal agreement is not sufficient. The terms must be clearly documented.
3. All Affected Beneficiaries Must Agree: Everyone who is giving up or receiving assets must agree and sign the document.
4. No External Consideration: No payment or benefit can be exchanged between beneficiaries in return for the variation.
5. Include Specific Tax Clauses: The deed must state that it is intended to take effect for IHT and CGT purposes.

Understanding ‘No External Consideration’

To effect a change, no one must receive any form of payment, service, or future benefit in exchange for agreeing to the change. This means that the variation must happen without any outside influence.

For example, if a beneficiary agrees to redirect their inheritance to a sibling in exchange for cash, this constitutes external consideration and renders the variation invalid for tax purposes.

However, rearrangements made purely within the estate—such as swapping items of equal value—are allowed. The distinction is subtle but important, and getting it wrong can have serious tax consequences.

Common Mistakes and Traps to Avoid

Many well-intentioned variations fail because of simple oversights or misunderstood rules. Here are the most common mistakes:

• Paying Legal Costs for Another Party: If one beneficiary agrees to cover another’s legal fees for the variation, this may count as consideration.
• Side Agreements or Promises: Any informal understanding that the new beneficiary will return the asset or share proceeds later can disqualify the variation.
• Poor Drafting: Failing to include the necessary tax clauses can render the variation ineffective for IHT or CGT purposes.

Case Examples of What Can Go Wrong

In some cases, beneficiaries have redirected assets to a spouse or parent and then received gifts or payments soon after. Even if not formally linked, HMRC may interpret these actions as a quid pro quo, resulting in the variation being invalid for tax relief.

Likewise, if the arrangement appears to be a disguised transaction, such as a sale rather than a gift, this will also trigger scrutiny. Even the suggestion of a benefit or inferred understanding can jeopardise the tax treatment.

When HMRC Scrutinises Variations

HMRC pays close attention to any deed of variation that results in assets being redirected to a spouse or charity, particularly if:

• The redirection results in significant tax savings.
• There’s evidence of prior discussions or expectations of repayment.
• Beneficiaries benefit indirectly, such as through subsequent gifts or arrangements.

To avoid complications, every variation should be drafted with full transparency and the benefit of professional advice.

Practical Tips for a Successful Deed of Variation

1. Seek Professional Advice Early: An experienced tax adviser or solicitor can help structure the variation correctly and avoid costly mistakes.
2. Document All Decisions: Keep a clear record of all discussions and decisions around the variation.
3. Include Tax Clauses: Ensure the deed includes the required statements for inheritance and capital gains tax treatment.
4. Avoid Any External Payments or Promises: Stick strictly to the estate and its existing assets.

A deed of variation is a valuable estate planning tool that allows families to adapt to changing circumstances, reduce inheritance tax, and honor unfulfilled wishes in the original will. For it to be effective, it must meet legal requirements and be free from external considerations. If you’re considering a deed of variation, our specialist team at Tax Accountant can help you draft and execute it properly, ensuring compliance with HMRC rules and achieving your desired outcomes.