Most people assume that when they receive an inheritance, there’s no tax to worry about.
And in many cases, that’s true. There’s usually no income tax or capital gains tax to pay at the point you inherit, and any inheritance tax (IHT) due will normally have been settled by the executor before the estate is distributed.
However, what many people don’t realise is that an inheritance today could increase the inheritance tax bill your own family faces in the future.
The hidden issue with inheriting assets
Imagine an elderly relative passes away and leaves behind an estate worth less than £325,000. Because it’s within the nil-rate band, no inheritance tax is due and you receive your share in full.
Inheritance tax is calculated based on the value of your estate, everything you own, including property, savings, investments and personal possessions such as artwork or jewellery. From April 2027, most pensions are also expected to be included as part of your estate.
Now suppose that among the items you inherit is a valuable painting worth £100,000. You take ownership of it and hang it on the wall, even though it’s not really to your taste.
While you haven’t paid any tax to receive it, your personal wealth has now increased significantly. Combined with your existing savings, home and investments, this extra £100,000 could push your estate above the nil-rate band. When the time comes, this may mean your own beneficiaries face a larger inheritance tax bill.
Even if the painting doesn’t generate income, it still forms part of your estate. Selling it would turn it into cash, which is still taxable within your estate. Giving it away wouldn’t remove the risk either, as gifts can remain part of your estate for inheritance tax purposes for seven years.
A simple solution: a deed of variation
There is a way to manage this situation.
A deed of variation is a legal document that allows beneficiaries to change how an inheritance is distributed after someone has passed away. If used correctly, it can help ensure assets go directly to the people who will benefit most, without increasing the size of your own estate.
In the example above, you could use a deed of variation to redirect the painting straight to your children. It would then be treated as if your relative had left it to them in the first place, rather than to you.
This means:
- The painting never forms part of your estate
- There’s no additional inheritance tax to worry about later
- Your children can keep or sell the asset as they wish
Without this step, the painting could effectively result in a £40,000 tax liability for your family in the future if your estate becomes liable for IHT at 40%.
How does a deed of variation work?
A deed of variation doesn’t have to be complex, but it must be done properly.
To be legally valid:
- It must be agreed and signed by all affected beneficiaries
- Signatures must be witnessed
- It must be completed within two years of the original death
- It must clearly set out what is being changed and who benefits
It may also be sensible to check the details against HMRC’s instrument of variation guidance to help ensure everything is handled correctly.
In some cases, a deed of variation can also be used to redirect inherited funds into a trust. This can allow you to continue benefiting from the money while keeping it outside of your estate for inheritance tax purposes.
Getting the right support
Anything involving inheritance tax can be complex, and small decisions made at the point of inheritance can have long-term consequences for your family.
With careful planning, it’s often possible to pass more wealth on to the next generation and reduce the amount lost to unnecessary tax.
At Continuum, we can help you understand your options, whether that’s using a deed of variation or planning more broadly for the future transfer of wealth within your family.
To discuss your inheritance plans and how to help protect what you pass on, speak to us today.
What is a deed of variation in a will?
This article is intended for general guidance only and is based on the opinion of Continuum it does not constitute financial advice. Individual circumstances vary, and you should consider seeking advice from a regulated financial adviser before making any decisions about your finances.
The Financial Conduct Authority does not regulate taxation and trust advice or will writing.
Levels and basis of reliefs from taxation are subject to change and their value depends upon your personal circumstances. We recommend that the investor seeks professional advice on personal taxation matters.
