Deeds of Variation are a common tool in post-death estate planning, allowing beneficiaries to redirect their inheritance. However, their use is subject to strict legal and tax limitations that are often misunderstood. This article explores what deeds of variation cannot achieve, aiming to clarify common misconceptions and help avoid unintended consequences.
Background
A deed (or instrument) of variation allows beneficiaries to redirect their entitlement under a will, intestacy, or survivorship under joint tenancy. The main provisions governing variations are found in the Inheritance Tax Act 1984 (A142) and the Taxation of Chargeable Gains Act 1992 (S62).
To be effective for inheritance tax and capital gains tax purposes, the variation must comply with certain formal requirements. Failure to meet these requirements may result in the variation being ineffective for tax purposes. This includes it being in writing, signed by all beneficiaries whose entitlement is being varied and being made within two years of death of the deceased.
A valid deed of variation will alter the inheritance tax and capital gains tax implications of the redirection, and for those purposes, it will be considered as if the gift had been made by the deceased’s estate and not by the beneficiaries.
However, it is important to note that this is only a variation for tax purposes. For other purposes, it is still considered as the original beneficiaries inheriting and then gifting their share away.
Whilst deeds of variation can be useful, there are a number of restrictions that need to be considered.
Care and Benefit Planning and Creditors
Deeds of variation cannot be used to avoid the impact of an inheritance on means-tested benefits or care fee assessments. If a beneficiary redirects their inheritance to another person or into trust, with the intention of reducing their own assets for the purpose of qualifying for state-funded care or benefits, this may be considered as deliberate deprivation of assets.
As noted, the variation is only a variation for tax purposes. For the purposes of deliberate deprivation, it is still considered as the original beneficiary inheriting and gifting away.
Similarly, a deed of variation cannot be used to defeat the claims of creditors of a beneficiary.
Example
A married couple own their home as joint tenants. The wife dies, with the husband receiving the whole property by survivorship. Shortly after her death, he creates a deed of variation to vary the wife’s share into trust with the intention of protecting this from future care costs. This could be considered as deliberate deprivation.
Varying Discretionary Trusts with Wide Classes of Beneficiaries
Varying a discretionary trust by deed of variation is possible, but there can be difficulties. A key restriction is that all the beneficiaries need to agree, including any minors or unborn beneficiaries. The class of beneficiaries of a discretionary trust is normally broad to be as flexible as possible and will often include beneficiaries born in the future and those who are minors, meaning a variation to a discretionary trust is likely not possible without court approval.
That said, this is not normally a concern with a discretionary trust, as the trustees could appoint the capital to the beneficiaries, and provided this is completed within two years of death, this will be a variation for inheritance tax purposes due to the operation of s.144 Inheritance Tax Act 1984.
Example
A will establishes a discretionary trust for “my descendants.” This will include beneficiaries born in the future and therefore a variation by the beneficiaries will not be possible.
Consideration From Outside of the Estate
A variation is only valid if it is made with no consideration in money or money’s worth. If there is consideration, the variation is invalid. The only exception is if the consideration is another variation or disclaimer which:
- relates to the same estate and
- in the case of inheritance tax, also qualifies for retrospective treatment
Example
John inherits a property from an estate. He wishes to create a deed of variation to vary the property to his brother James. James is intending to pay market value for the property to John. As there is consideration, the variation is invalid.
Varying Interests Multiple Times
It is not possible to create a deed of variation on an asset multiple times. It can only be validly varied once.
However, it is possible for an asset to receive retrospective treatment for inheritance tax under both s.142 and s.144 in certain circumstances:
- Trustees of a relevant property trust could appoint an asset to a beneficiary and s.144 would apply. That beneficiary could then create a deed of variation under s.142.
- A beneficiary could vary their inheritance to a relevant property trust by deed of variation under s.142. The trustees of the relevant property trust could later appoint the same asset to a beneficiary of the trust and s.144 would apply.
Example
Harry inherited a property from his mother. He varies 50% of the property to his son Daniel. Daniel wants to transfer this to his daughter, but cannot create a deed of variation as it is not possible to vary it twice.
Beneficiary Without Capacity
A beneficiary without capacity cannot make a variation themselves. If the beneficiary has a court-appointed deputy or an attorney under an enduring power of attorney or lasting power of attorney, it may be possible for the attorney or deputy to make a variation in certain circumstances. This would be considered as a gift and their gift-giving powers are limited. The attorney or deputy would most likely need to seek approval of the Court of Protection before making the variation.
Where an original beneficiary with capacity wishes to vary an inheritance to a beneficiary without capacity, this will be possible.
Varying the Will of the Deceased
A deed of variation cannot be used to correct errors or ambiguities in the will itself. Where rectification is required, an application must be made to the court under the Administration of Justice Act 1982.
Death of Beneficiary Before Variation
Where a beneficiary entitled to an interest in an estate dies, it is possible to vary the deceased beneficiary’s entitlement to the first deceased’s estate. This variation would normally be made by the personal representatives of the deceased beneficiary (with the consent of the beneficiaries of the deceased beneficiary).
Any variation would need to be made within two years of the death of the first deceased to be valid.
The subject of the variation must also still exist. This creates particular problems where the deceased beneficiary was only entitled to a life interest. HMRC consider the ‘property’ for any variation to be the right to income arising under the trust. On the death of the life tenant, that right is terminated and no longer exists. It would therefore not be possible to create a variation to a life interest after the death of a life tenant, even if it is still within two years of the original deceased’s death.
Example
Mr Black dies and leaves his wife, Mrs White, a life interest in the estate, with the trust fund passing to Mr Black’s children on her death. Mrs White dies one year later. One of Mr Black’s children wishes to vary their inheritance to their siblings. As Mrs White has died, the subject of the variation no longer exists and it would not be possible to create a variation to Mr Black’s estate.
Conclusion
Practitioners and beneficiaries should approach deeds of variation with a clear understanding of their legal and tax implications. Missteps can invalidate the arrangement or lead to unintended outcomes. Understanding these boundaries is essential to ensure effective estate planning.
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