When someone dies, their estate is distributed according to their Will or, if there is no Will, under the rules of intestacy. However, sometimes the beneficiaries may feel that the inheritance they receive is not structured in the most tax-efficient way or that it does not align with their own wishes. In these circumstances, a deed of variation may be used to adjust the way an estate is distributed; potentially reducing tax liabilities, providing for other family members, or improving the way an estate is structured. It therefore represents an important estate planning tool, and one which should not be overlooked when administering estates. 

What is a Deed of Variation?

A deed of variation is a legal document that allows beneficiaries of an estate to change the way an inheritance is distributed. This can be done without legal challenge, or tax penalties, provided the variation is made within 2 years of the deceased’s death and all the relevant parties agree. It can be used to redirect part or all an inheritance to other individuals, trusts, or charities allowing for greater flexibility in estate distribution. 

Why use a Deed of Variation?

1.    Reducing Inheritance Tax (IHT)

One of the key advantages of a deed of variation is that if addressed correctly it will benefit from retrospective tax treatment, which means that HM Revenue & Customs will treat the changes made by the beneficiary as if they were made by the deceased themselves. For example, if an estate exceeds it’s IHT threshold, a Deed of Variation can assist to reduce IHT by redirecting assets to non-chargeable beneficiaries, for example a spouse or civil partner (who is IHT-exempt) or charities (which are also IHT-exempt). In the case of gifts to charity, if the gifts made amount to 10% or more of the estate, the remainder of the estate will qualify for a reduced rate of IHT of 36% instead of the usual 40%, which could lead to a reduction in the amount of IHT paid.

2.    Providing for family members if they were overlooked

Sometimes beneficiaries will be concerned that a Will or the rules of intestacy, do not make adequate provision for a dependent, such as a child, or a partner. In these circumstances, a Deed of Variation can reallocate part of the estate to ensure that these dependents are provided for, which may help to prevent or resolve any disagreements that may otherwise arise. 

3.    Redirecting inheritance to the next generation

Some beneficiaries may not need their inheritance and may feel that it will only add to their own IHT burden. They may, therefore, prefer to pass their inheritance directly to their own children or grandchildren to assist with their own estate planning. The retrospective tax treatment referred to above prevents this onward gift being considered when assessing the beneficiary’s chargeable estate, as it will be treated as if it were made by the deceased for IHT purposes.

Key requirements for a deed of variation

To be valid, a deed of variation must meet the following conditions:

1. All the affected beneficiaries must agree to the changes
2. It needs to be completed within 2-years of the date of death (and can usually be made either before or after a Grant of Representation has been issued).
3. The changes must be in writing and signed.

The following issues also need to be carefully considered:

1. A deed of variation cannot be used to avoid creditors if a beneficiary has outstanding debts.
2. It cannot be used to alter the appointment of executors or guardians in a will.
3. If a variation affects minors (i.e., children under 18) or unborn beneficiaries, court approval is likely to be required.
4. If the beneficiary wants the deed of variation to benefit for retrospective IHT and/or CGT treatment, it is essential to include the relevant tax statement in the deed of variation. Without this statement, the beneficiary will be treated (for tax purposes) as having made the disposal themselves, which could result in undesirable tax implication if the asset has increased in value, or if the beneficiary fails to survive 7-years.
5. If a deed of variation results in an increase in IHT or CGT, a copy of the deed will need to be submitted to HMRC within six months of its completion. However, if the deed of variation does not alter the tax position, there is no requirement for HMRC to be notified.
6. The retrospective IHT and CGT treatment secured by a deed of variation will not apply if there has been any consideration brought in from outside the estate. For example, if a father died leaving his estate worth £1m to his children, they could enter into a deed of variation to redirect the estate to their mother. In these circumstances the retrospective IHT and/or CGT treatment would apply (so that the father’s estate could then benefit from spouse exemption). However, this retrospective tax treatment would be lost if the mother were to use £1m from her own resources (or borrow the money) to compensate her children for the loss of their shares in their father’s £1m estate, as this would represent extraneous consideration. In these circumstances, spouse exemption would be denied and the £1m estate would remain chargeable to tax.  

Do I need to take professional advice when making a Deed of Variation

Although a deed of variation can be created without a solicitor, we recommend that anyone considering this option takes professional advice to ensure that the legal and tax implications are carefully considered and addressed before a deed of variation is completed. 

Final considerations

As an alternative to a deed of variation, a beneficiary may consider disclaiming their interest under a Will or the intestacy rules instead. A disclaimer differs from a deed of variation, as the beneficiary has no control over where the disclaimed inheritance passes. Instead, it falls back into the deceased’s estate to be distributed in accordance with the terms of their Will or the intestacy rules, but on the basis that the disclaiming beneficiary is treated as having predeceased.

How we can help

The importance of deeds of variation as estate planning tools and the need to seek specialist advice in relation to this should be taken into consideration. Our estate planning team at Porter Dodson will be more than happy to talk you through the implications and explain in full the process.