Using a deed of variation to save inheritance tax for an unmarried couple

Our client (“Jane”) came to us for advice in relation to her own will following her long-standing partner’s (“Peter”) death. Jane has an adult daughter and wants her estate (worth around £1.3 million) to pass on her death to her daughter (with substitution of future grandchildren).

Unfortunately, as Jane and Peter weren’t married or in a civil partnership at the time of his death, her estate won’t benefit from the enhanced inheritance tax (“IHT”) allowances.

In short, every individual has an IHT allowance referred to as the nil rate band (currently £325,000). There is also an additional IHT allowance referred to as the residence nil rate band (currently £175,000) which is available if certain criteria are met. However, unmarried couples do not have the same IHT benefits as their married counterparts. There is no spouse exemption, and the unused nil rate band and residence nil rate band (if applicable) are not transferable between an unmarried couple.

As things stand, Jane’s estate will benefit from £500,000 in IHT allowances (instead of potentially £1 million had she and Peter been married or in a civil partnership at the time of his death) meaning an IHT bill of around £320,000.

The simplest form of estate planning is to give assets away that you no longer require. As long as you survive the gift(s) by seven years, the value(s) fall out of your estate for IHT purposes. However, as Peter died less than two years ago, Jane could consider diverting some or all of the assets she inherited from him to a discretionary trust from which she, her daughter and future grandchildren can benefit. The purpose of the trust is to keep the value out of the beneficiaries’ taxable estates and mitigate a double-IHT charge. As long as the deed of variation is signed within two years of Peter’s death, the transfer of value will be treated, for IHT purposes, as having been made by him (so no need for Jane to survive for seven years) – it is one of the rare exceptions where you can create a trust and still be a beneficiary without IHT problems arising.

Jane could also consider using the exemption for normal expenditure out of income. This is quite a helpful exemption as gifts which fall within the criteria are fully exempt from IHT at the time they are made, with no question of waiting a seven year period. To qualify, the gifts need to be made out of income, and not capital; they need to have some element of regularity, rather than being a one-off payment as sporadic gifts don’t qualify for the exemption; and taking one year with the next, the amount given needs to fall within surplus income.

As Jane’s story shows, it’s important to take advice from our estate planning specialists at an early stage so you’re aware of the various options available to you.