What is a deed of variation and how can it reduce inheritance tax?

Full answer

A deed of variation (sometimes called a deed of family arrangement) is a flexible and widely used estate planning tool that allows beneficiaries to change how an estate is distributed after someone has died, provided all affected beneficiaries agree and the variation is made within the required time limit. **The two-year time limit** To be effective for Inheritance Tax and Capital Gains Tax purposes, a deed of variation must be executed within two years of the date of death -- variations made after this window may still be legally valid between the parties involved, but will not receive the special tax treatment that makes deeds of variation attractive for estate planning. **How it reduces Inheritance Tax** A common use is where an estate is left to someone who does not need the money (for example, a surviving spouse who already has substantial assets, or an adult child who is themselves comfortably provided for), and that beneficiary chooses to redirect some or all of their inheritance to grandchildren, or to charity. If the redirected amount goes to a charity, it may reduce the estate's overall Inheritance Tax bill (charitable gifts are exempt from IHT, and leaving 10% or more of the net estate to charity can also reduce the IHT rate on the remainder from 40% to 36%). Redirecting to grandchildren does not reduce the immediate IHT bill on the original estate, but can be a more tax-efficient way of getting assets to the next generation without them first passing through, and potentially adding to, the original beneficiary's own estate (avoiding a second potential IHT charge when that beneficiary later dies). **"Reading back" to the date of death** The key legal mechanism is that, provided the deed is executed within two years and meets the formal requirements (including an election under the relevant tax legislation, usually included as a specific clause within the deed itself), the variation is treated for Inheritance Tax and Capital Gains Tax purposes as though the deceased had left their estate this way in the first place -- rather than being treated as a gift FROM the original beneficiary to the new beneficiary, which would otherwise potentially create its own tax consequences (like starting a new seven-year gift clock for the original beneficiary's own estate). **Who must agree** All beneficiaries whose entitlement is reduced by the variation must consent to it -- you cannot use a deed of variation to redirect someone else's inheritance without their agreement; it must be the choice of the person originally entitled to receive that share. **Common practical uses beyond tax** Beyond pure tax planning, deeds of variation are also used to correct situations where a will is outdated or does not reflect the family's current wishes, to provide for someone who was left out of a will (though this needs the agreement of those whose shares would be reduced), or to resolve family disputes about how an estate should practically be divided. **Formalities and professional advice** A deed of variation must be in writing, signed by all relevant parties, and should specifically state that it is intended to have effect for Inheritance Tax and/or Capital Gains Tax purposes under the relevant legislation -- getting this wrong can mean losing the beneficial "reading back" tax treatment entirely, so professional legal and tax advice is strongly recommended rather than attempting a DIY deed for anything beyond very simple situations. **Worked example** A mother dies leaving her £600,000 estate entirely to her financially comfortable adult son, who does not need the money. Within the two-year window, the son executes a deed of variation redirecting £100,000 of his inheritance to his two children (the deceased's grandchildren) and £50,000 to a charity. The charitable gift reduces the estate's taxable value and may help the estate qualify for the reduced 36% IHT rate if the charitable proportion meets the required threshold; the grandchildren receive their inheritance directly, without it needing to pass through and potentially be taxed again in the son's own estate later. **Practical tip** If you are considering a deed of variation for tax planning purposes, act well within the two-year deadline (leaving things to the last minute risks missing the window due to delays in estate administration or professional advice), and always use a solicitor experienced in this specific area, since the tax treatment depends entirely on getting the legal drafting correct.

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