Unlocking Savings: Navigating the Inheritance Tax Loophole

In recent discussions about inheritance tax (IHT), a unique loophole has come to light, enabling families to significantly reduce their tax liabilities. Financial advisors are increasingly employing this strategy for their clients, particularly in the wake of Chancellor Rachel Reeves’ anticipated changes to the inheritance tax laws.

Growing Interest in Estate Planning

With potential revisions to the IHT regime on the horizon, there has been a notable rise in inquiries about estate planning. A recent report from wealth management firm Rathbones indicated that nearly 10% of estates subject to inheritance tax had liabilities exceeding £500,000 during the tax year of 2021/22. If current trends continue, Rathbones predicts that by 2025/26, approximately 3,524 estates will face IHT bills surpassing £500,000.

These rising figures are prompting many families to reassess their estate strategies, particularly as new rules regarding pensions—where unused retirement savings will be considered part of an estate—are expected to come into effect in 2027. To navigate these complexities, families are turning to lesser-known methods to mitigate their tax burdens.

Understanding the Deed of Variation

What is a Deed of Variation?

One of the most effective tools for managing inheritance tax is the deed of variation. This legal document allows beneficiaries to redirect some or all of an inheritance within two years of the original owner’s death. This redirection can significantly lower an estate’s IHT liability by passing assets to others, such as children or into a trust.

How Does a Deed of Variation Work?

According to Simon Bashorun, head of advice at Rathbones, interest in deeds of variation is rising as families look to ensure their inheritances align with long-term financial goals, including tax efficiency. Here’s how it works:

• Redirecting Inheritance: Beneficiaries can adjust will terms to change how the estate is distributed, allowing HMRC to treat any redirected gifts as if they were directly from the deceased. This can help mitigate inheritance tax.
• Skip a Generation: For example, if a child inherits more than they need, they may pass some assets directly to their children. This skips a generation and can curb future IHT costs, avoiding a tax hit twice.
• Charitable Donations: Another strategy involves leaving a portion of the estate to charity, which can lower the estate’s taxable value and reduce the IHT rate from 40% to 36% if at least 10% of the estate is given to charity.

The Benefits of a Deed of Variation

A deed of variation not only allows for tax savings but also helps in various scenarios, such as:

• Trust Establishment: Placing assets into a trust is beneficial, particularly if young beneficiaries are involved or if protection from future taxes is desired.
• Including Additional Beneficiaries: The deed can accommodate beneficiaries not initially included in the will, such as stepchildren or late-born children.

However, it is vital that all affected beneficiaries agree unanimously to the changes, a challenge that can be especially daunting when money is involved.

Making Strategic Decisions with Financial Advisors

How Much Can You Save?

Scott Gallacher, director at Rowley Turton, emphasizes that financial advisors are now frequently discussing deeds of variation with clients, especially as more families face IHT hurdles due to government changes. He notes that adopting this strategy can lead to substantial six-figure tax savings while providing protection against future issues like divorce settlements or long-term care fees.

Tips for Families:

• Begin conversations about deeds of variation early, despite the potential for resistance from family members.
• Engage professional advisors to ensure the variations are executed correctly, helping avoid pitfalls in the process.

Seeking Professional Guidance

Samuel Mather-Holgate, an independent financial advisor, acknowledges that these tools have been underutilized historically, but changing IHT rules are likely to encourage families to rethink their strategies. He stresses that families must be proactive in exploring these options to avoid long-term financial pitfalls.

Conclusion

The inheritance tax landscape is evolving, and the emergence of strategies like the deed of variation presents a valuable opportunity for families seeking to preserve their wealth. By understanding and utilizing these financial tools, they can both secure their legacies and optimize tax efficiency for future generations. Engaging a professional to navigate these complexities is essential for making informed and beneficial decisions.

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