Tax planning with deeds of variation

When someone dies, their estate is divided between beneficiaries. This is done either in accordance with the deceased’s will, under the rules of intestacy or by survivorship – where there are jointly held assets and surviving joint-owners.

In some circumstances, a beneficiary may want to redirect or rearrange the assets which they are due to inherit by entering into a deed of variation. Before doing so, expert advice should be taken by the beneficiary and the personal representatives of the estate, to ensure that the desired outcome is achieved, and that the legal and tax implications have been properly considered.

A deed of variation allows the original beneficiary to control the redirection of all or part of the estate they are entitled to, but there are certain requirements that must be complied with. The variation must be in writing, but it can take place even after assets have been distributed to the original beneficiary. To have retrospective effect for inheritance tax (IHT) and capital gains tax purposes, the deed must be signed within two years of the date of death and must include the relevant statements.

If done correctly, the original beneficiary avoids making any lifetime gifts to the new beneficiary from their own estate for tax purposes. Instead, the gifts are treated as if they were made by the deceased on their death.

There are a number of reasons why a beneficiary may want to enter into a deed of variation. They may wish to provide for family members who are in greater need than the beneficiary, or for someone who the deceased believed would inherit but does not – such as a cohabitee who the deceased assumed would inherit under the intestacy rules.

It may be to skip a generation and provide for grandchildren rather than financially independent children for whom it would create an IHT issue of their own.

Saving tax can be another major factor in someone’s decision to vary their entitlement to an estate. They may wish for the personal representatives to take advantage of a reduced rate of IHT by giving 10% of the net estate to charity.

The redirection of assets may also mean that further tax allowances or exemptions can be claimed. For example, directing a main residence to children or grandchildren could mean that the ‘additional residence nil rate band’ – an additional tax-free amount which can be passed on against the value of the home – becomes available to the estate. A non-exempt beneficiary (such as a child) may wish to redirect assets to an exempt beneficiary (such as the deceased’s spouse) to avoid IHT on the first of his or her parents’ death.