INHERITANCE Tax (IHT) begins to be paid on an estate valued at more than £255,000.

This is the individual's personal exemption. That figure must also allow for recent lifetime gifts.

This used to seem a large sum, but for many people, the rising values of a house, life policies and savings can bring them near enough to this figure to be concerned that IHT might be payable.

People can have strong, valid, and widely differing views on tax planning, but it is not normally necessary to make complicated arrangements in a will to avoid the payment of IHT.

It does become more difficult as the value of the estate rises well above the personal exemption. IHT is paid at 40 per cent on the amount over the limit. This is the "marginal rate".

The effective overall rate starts low, but climbs as the total goes up. At £260,000, the tax payable is £2,000 (less than one per cent overall). At £350,000, it is £38,000 (11 per cent).

At £500,000, the figure is £98,000, or 20 per cent, and at £750,000, the figure is £198,000, or 26 per cent.

A gift to a surviving spouse is exempt from IHT. Where husband and wife each have unused personal allowances, a simple gift from one spouse to another of all the estate does not make use of the personal exemption, since the gift to the spouse is exempt.

When the second partner dies, the combined estates can be quite considerably larger, but only one tax allowance remains available, and a substantial amount of tax can then come to be payable.

That sum might have been reduced by use on the first death of the individual IHT allowance. The law provides a sensible way of dealing with this.

When most people make their will, they do not know when they are going to die.

One consequence of this is that many wills prove to be less tax-efficient than they would be if that person had made their will just before his or her death to take account of the tax laws in force at the time.

However, the people who will benefit from the will (the beneficiaries) can often overcome this problem by using a Deed of Variation (DOV).

A DOV allows a beneficiary under a will, or a beneficiary under the laws of intestacy if there is no will, to redirect his or her benefit to another person of his or her choosing.

This means that beneficiaries can take full account of family circumstances, and the tax laws, at the time of death. The estate can then be distributed in the most tax-efficient way possible.

However, as you would expect, there are strict rules that have to be followed for a DOV to be valid. These rules include the following:

* The DOV must be made within two years of the deceased's death

* For the deed to be effective for IHT purposes, the Capital Taxes Office should be told within six months of the deed being made

* For the deed to be effective for Capital Gains Tax purposes, the Inland Revenue should be told within six months of the deed being made

* For Income Tax purposes, any income arising between the date of the deceased's death and the date of the deed is usually considered to belong to the original beneficiary.

The greatest tax advantage of making a DOV is that any benefit redirected under the deed is treated, for IHT purposes, as having been directed by the deceased.

This means that the person making the variation does not need to then live for the normal period of seven years after making the gift for the gift to become free-from IHT. For this reason, DOVs are a vital part of IHT planning for many people.

* John Dresser is a director of Hennessey and Partners independent financial advisors. Tel (01325) 488556.

John Dresser is an independent retirement planning specialist and director at Hennessey and Partners based in Darlington. He can be contacted on (01325) 488556.

Published: 02/12/2003