Having a will is arguably the most important part of estate planning as it ensures that there is no misperception over how your estate should be dealt with and by whom.
But what happens when someone dies and the beneficiaries do not agree with the directions in their will? Perhaps things have changed since it’s writing, or maybe it overlooked the beneficiaries’ situations. There is the possibility that no will was ever written, or a life event (such as a divorce) has rendered parts of it invalid.
A Deed of Variation (DoV) is a good option to reallocate the estate to fit the family’s conditions better.
How Does a Deed of Variation Work?
A DoV is created after death to effectively rewrite the deceased person’s will. It is as if they would have updated the will themselves.
The estate can be passed to different beneficiaries or into a trust. On the other hand, you can use a DoV to modify the proportions inherited by the beneficiary.
It’s a good idea to seek legal and financial advice before progressing with a DoV to ensure that you proceed with the most tax-efficient option.
What Are the Conditions?
The conditions for being able to enact a DoV are:
- It must be done within two years of death.
- All of the original beneficiaries need to be in agreement.
- It must be clear and explicit regarding the assets to be varied.
- It needs to include a specifically worded statement that it should be effective for Inheritance Tax and Capital Gains Tax purposes.
How Can a DoV Reduce Inheritance Tax (IHT)?
If your estate passes to anyone other than your spouse, the value over the nil rate band (currently £325,000) may be taxed at a rate of up to 40%. Transfers between spouses are exempt, and married couples can enjoy a joint nil rate band (currently £650,000). An additional residence nil rate band (currently £175,000 per person) may be available if the estate includes a main residence.
A DoV can reduce IHT in the following ways:
- If the beneficiaries are adult children and are likely to face an IHT liability themselves, they can vary the estate so that their children benefit. This keeps the assets out of their own estate and avoids increasing their potential IHT bill. While they could designate to inherit and then gift the assets, it would take a further seven years for the value to drop out of their estate.
- If the estate is large and IHT is likely to be an issue throughout the generations, another option is to vary the estate into trust. This effectively means that the assets are not owned by any one individual but can be accessed by a number of beneficiaries. This can avoid increasing the estate of any individual; however, trusts can sometimes carry tax consequences which is why it is crucial to seek expert advice.
- If the original will (or rules of intestacy if no valid will is available) intended to pass assets to anyone other than a spouse, this would use up some or all of the deceased person’s nil rate band. This could incur IHT if the amount inherited is over £325,000. However, as previously mentioned, transfers between spouses are exempt. In some situations, particularly if the surviving spouse is fairly young, it may be suitable to vary all of the estate to them. This can ultimately reduce IHT on first death.
- However, in some circumstances, it may actually be more appropriate to make use of the deceased person’s nil rate band by varying the assets to another beneficiary, or into a trust.
- It would also be possible to leave some, or all of the estate to charity via a DoV. Like with spouses, charitable gifts are also exempt from IHT. Furthermore, if at least 10% of the estate is left to charity, the tax liability on the remainder is reduced to 36%.
What Are the Disadvantages?
There are a few potential disadvantages to using a DoV:
- Unless the assets are passed to a spouse or a charity, there is no immediate relief from IHT.
- The beneficiaries may not all be in agreement, particularly if the chosen course of action goes against the deceased person’s wishes.
- It is legally complex and there can be tax consequences for getting it wrong.
- Legal advice is necessary, and this incurs a cost.
- It’s not possible to change your mind once the DoV has been enacted.
If all of the beneficiaries are happy with the DoV and legal advice has been taken, the advantages generally outweigh the drawbacks.
Some Other Options for Reducing IHT
A DoV might be useful for the beneficiaries of an estate, but there are a number of things you can do during your lifetime to reduce your potential IHT liability, including:
- Ensuring your will is set up tax-efficiently.
- Making gifts, either directly or into trust, to reduce the value of your estate.
- Investing in business assets, including Alternative Investment Market (AIM) shares and certain types of unlisted companies. If you hold the assets for two years, they will normally benefit from business relief and be exempt from IHT. This is a higher-risk strategy and seeking advice is recommended.
- Setting up insurance policies to pay the tax. While this doesn’t reduce your IHT liability, it offers the executors a means to pay the tax quickly without having to sell assets from the estate.
A DoV can be very useful and offers great flexibility; but controlling your estate plan during your lifetime can be even more beneficial.
Please don’t hesitate to contact a member of the team to find out more about estate planning.