Deeds of Variation – A Way to Share your Inheritance with Others

This blog considers some of the options for those looking to forfeit or redirect inheritance and pass the assets on to others. It considers the tax implications of making outright gifts and the advantages of putting a Deed of Variation in place.

Following the passing of a loved one, you should look to the relevant Will or rules of intestacy to determine where that person’s assets will be transferred. You may find yourself due to receive inheritance from the estate.

When you foresee yourself receiving inheritance, it may be appropriate to ask questions such as:

• Do I really need all/any of my inheritance?
• Would my family and friends benefit from receiving a share of the inheritance?
• Would the inheritance affect the size of my own estate for Inheritance Tax purposes?

Depending on the answers to the above, you may seek to nominate a new recipient for all or part of your share of the inheritance. One tax-efficient way to achieve this is to create a Deed of Variation.

The Problems with Outright Gifting

Should you find yourself with surplus assets which you’d like to share with others, you may decide to gift them. This is, usually, very easy to do – you simply transfer the asset to the person of your choice. This can usually be done at any time of your choosing.

However, unless the gift is of a very small value, there are some drawbacks to making an outright gift. It is important to consider the tax consequences of gifting.

Currently, every person is able to gift £325,000 worth of assets, free from Inheritance Tax, from their estate to others. This is known at the ‘Nil Rate Band’. In certain circumstances, the ‘Residential Nil Rate Band’ may provide an Inheritance Tax exemption of £175,000 in relation to residential property. These tax allowances are transferable between spouses where unused, so some estates may be able to transfer up to £1,000,000 worth of assets free from Inheritance Tax. Should a person make gifts to a collective value in excess of the nil rate bands applicable to their estate, Inheritance Tax of 40% becomes payable on the surplus assets. This applies to gifts given both during the person’s lifetime and after their passing (i.e. under their Will or by the rules of intestacy).

The 7-year rule must be considered. Where a person makes a certain gift and survives more than 7 years after this, the nil rate bands are no longer affected by such gift.

Where a person makes a gift but reserves a benefit in the asset gifted, for example where a parent gifts a holiday home to their child but stays in it from time-to-time without paying a market rent, the gift is deemed to remain a part of the person’s estate for Inheritance Tax purposes even if the gift was made more than 7 years prior to death.

The tax considerations surrounding gifting are plentiful and complex. The main thing to note is that making outright gifts during your lifetime can carry substantial tax implications. So, if you inherit assets which you feel you don’t need, how can you transfer them to your chosen beneficiaries without incurring such tax consequences? The Deed of Variation plays an important role here.

Deed of Variation

A Deed of Variation may be used to record a declaration, made by the original beneficiary(ies) of an estate, that assets due to be inherited are to be transferred to newly chosen beneficiaries, or to the same original beneficiaries but in different shares.

A Deed of Variation must be executed within 2 years of the passing of the deceased person to avoid the usual tax consequences of gifting. Practically, it is advisable for the deed to be executed before inheritance is received by the original beneficiary (so the assets are passed directly from the estate to the new beneficiary, without the original beneficiary having to take possession). The deed must be signed by the original beneficiary and witnessed by an independent witness.

Deeds of Variation do not affect the Wills they vary. Only the inheritance of the beneficiaries executing the deed is affected. Similarly, where the deceased left no Will, deeds do not affect the rules of intestacy as they apply to other beneficiaries who have not chosen to vary their inheritance.

The effect of such deed is that the person originally due to receive the varied inheritance is, for Inheritance Tax purposes, deemed never to have received the inheritance. The person benefitting from the variation is deemed to have taken the assets directly from the deceased’s estate.

Advantages of using a Deed of Variation

Deeds of Variation allow for great flexibility in distributing the assets of an estate. Likewise with gifting, an original beneficiary can choose to do as they please with their inheritance. For example, an original beneficiary set to receive £15,000 may declare that £10,000 should instead be sent to their best friend. Alternatively, where two original beneficiaries are each due to inherit a half share in an estate, they could both declare that they will only take a 25% share each, so a new beneficiary of their choice could inherit a 50% share.

Where a deceased person does not leave a Will, the application of the rules of intestacy may not result in estate assets being distributed in the way that the deceased person may have wished. A Deed of Variation may provide an opportunity for beneficiaries to ensure that the deceased’s wishes are fulfilled. For example, should the deceased’s family know that the deceased wished for their sister to receive a gift of £5,000 upon the deceased’s passing, but only their spouse is set to inherit as per the rules of intestacy, the spouse can choose to execute a deed to give effect to the gift to the sister out of their own inheritance.

As above, when inheritance is varied by an original beneficiary and passed to a new beneficiary by Deed of Variation, the original beneficiary is treated as having never received the relevant inheritance. This means that the above-mentioned tax repercussions of making an outright gift are not relevant. Inheritance Tax on the deceased’s estate itself will still be payable, of course, but no additional tax liabilities arise by way of gifting.

Additionally, because the original beneficiary is deemed not to have received the inheritance at any point, their estate is not increased by the inheritance originally due to them. Their estate is therefore smaller than it would have been if they’d have accepted the inheritance. This can be of significant benefit. For example, consider the situation where a person loses their parent, and they have an adult child of their own. The person may be due to inherit £200,000 cash from their parent, but their estate may already be large enough to exceed the applicable nil rate bands, and they do not need the £200,000 themselves. Here, they may choose to execute a Deed of Variation so that the £200,000 passes directly to their adult child. There are two principal benefits to this: the adult child will be able to use the money immediately, and there will be no need to pay additional Inheritance Tax which would have arisen if the original beneficiary had kept the funds in their own large estate until their death.