When managing an estate, unforeseen complexities can arise that may prompt the need for alterations to the distribution of assets as outlined in a will. One legal instrument that facilitates this change is a deed of variation. This tool allows beneficiaries to rearrange or redirect their inheritance to meet personal, familial, or tax-planning objectives, potentially altering the original terms of the will.
Understanding what a deed of variation is and how it can be effectively used is crucial for anyone involved in estate planning or the execution of a will. This blog post explores the intricate details of deeds of variation, their legal implications, and practical considerations, aiming to provide a thorough understanding of why they might be necessary and how to implement one properly.
Definition and Basic Principles of a Deed of Variation
A deed of variation, sometimes referred to as a deed of family arrangement, is a legal agreement that allows beneficiaries of a deceased’s estate to alter the distribution of that estate. This agreement must be made within two years of the death and can change how the assets are distributed, either under the terms of the will or under the rules of intestacy if there was no will.
Legal Basis
The validity of a deed of variation is recognised under UK law, specifically mentioned in the Inheritance Tax Act 1984 and the Capital Gains Tax Act 1979. This recognition allows for the retrospective application of these changes for tax purposes, assuming certain conditions are met.
Primary Purposes
The primary purposes of executing a deed of variation include:
- Tax Planning: To reduce the inheritance tax liability by redirecting assets to beneficiaries, such as charities, who are exempt from tax.
- Correcting Mistakes: To address any apparent errors or oversights in the will.
- Equalising Inheritances: To adjust the inheritances among family members or dependents to reflect a fairer distribution or changed circumstances.
Deeds of variation can only be created with the consent of all beneficiaries who would be affected by the changes. This ensures that all parties are in agreement, thereby preventing potential disputes and maintaining family harmony.
Reasons for Using a Deed of Variation
There are several compelling reasons why beneficiaries might choose to use a deed of variation. Understanding these motivations can help clarify when and how this legal tool should be applied.
Tax Planning
One of the most common reasons for executing a deed of variation is tax planning. By redirecting parts of an inheritance to beneficiaries like charities or to those who may have a lower tax rate, the overall inheritance tax liability on the estate can be reduced. This is not only beneficial for the beneficiaries due to the reduced tax impact but also maximises the efficient use of the deceased’s assets.
Fairness Among Beneficiaries
In some cases, the original terms of a will may not seem fair to all parties involved, possibly due to changes in circumstances after the will was written. A deed of variation allows these terms to be adjusted to ensure that the estate is distributed more equitably among the beneficiaries. This could involve increasing the share of someone who has since fallen into financial hardship or providing for a family member born after the will was made.
Correcting Mistakes
Occasionally, errors or oversights occur in the drafting of a will, or new information may come to light after the testator’s death that they were unaware of. A deed of variation can be used to rectify these mistakes, ensuring that the estate is distributed according to what would have likely been the deceased’s wishes if they had the correct information at the time of writing their will.
Tax Implications of a Deed of Variation
The tax implications of a deed of variation are particularly important and can be highly beneficial if properly managed.
Inheritance Tax
A deed of variation can be used to redirect assets in a way that reduces the overall inheritance tax due on an estate. For instance, redirecting a portion of the estate to a spouse or a charity can significantly decrease the tax liability, as transfers to spouses are exempt from inheritance tax and donations to charity can reduce the inheritance tax rate on the rest of the estate.
Capital Gains Tax
For capital gains tax purposes, any asset disposed of through a deed of variation is treated as having been acquired by the new beneficiary at the original base cost of the deceased. This can be particularly advantageous if assets have appreciated significantly in value.
Conditions for Tax Effectiveness
To ensure that a deed of variation is effective for tax purposes, it must be signed within two years of the death, and all affected beneficiaries must agree to the changes. The deed must also include a statement that all parties intend for the variation to be effective for tax purposes.
The Legal Process for Creating a Deed of Variation
Creating a deed of variation involves several important steps and legal formalities.
Step-by-Step Guide
- Agreement Among Beneficiaries: All beneficiaries affected by the proposed changes must agree to the variation.
- Draft the Deed: The deed should be drafted by a legal professional to ensure all legal requirements are met and the document is clear and binding.
- Sign the Deed: The deed must be signed by all agreeing parties and witnessed, as per the standard requirements for legal documents.
- Notify Relevant Parties: Once signed, it is essential to notify any institutions holding assets of the estate, such as banks or investment firms, of the changes.
Legal Formalities
The deed must clearly state that the parties involved intend for the changes to apply for both inheritance tax and capital gains tax purposes. This declaration ensures the tax authorities recognise the variation.
Time Limits
The deed must be completed and signed within two years of the deceased’s death to qualify for retrospective tax treatment.
Potential Risks and Limitations
While deeds of variation are powerful tools, they come with potential risks and limitations.
Risks
- Disputes Among Beneficiaries: Even with initial agreement, disputes can later arise, particularly if the implications of the variation are not clearly understood by all parties.
- Complex Tax Implications: Incorrect handling of a deed of variation can lead to unexpected tax consequences, making professional advice crucial.
Limitations
- Irrevocability: Once a deed of variation is signed, it is generally irrevocable, binding all parties to the new terms.
- No Benefit to the Declarant: Beneficiaries cannot use a deed of variation to benefit themselves directly; it can only be used to redirect their inheritance to others.
Conclusion
A deed of variation is a versatile and valuable tool in estate planning, offering beneficiaries the flexibility to alter the distribution of an estate in a way that meets their current needs and objectives. Whether it’s addressing fairness, correcting oversights, or optimising tax liabilities, a deed of variation can provide a tailored solution that respects the spirit of the deceased’s wishes while adapting to the realities of the beneficiaries’ lives.
However, due to the complexity and potential risks involved, it is advisable to consult with legal professionals before proceeding. With the right guidance, a deed of variation can be an effective means of managing an estate posthumously, ensuring that it serves the best interests of all parties involved.
This blog post has aimed to cover the essential aspects of what a deed of variation is, why it might be used, and how to implement one successfully. If you’re considering such a measure, take this information as a starting point for further discussion with your legal advisor.
