For clients who are due to or have inherited wealth which will potentially give them an IHT issue, implementing a deed of variation could be the answer to the problem. Here the M&G Wealth technical team address five important Q&As regarding the use of DOVs.
Section 142 of IHTA 1984 permits the “alteration of dispositions taking effect on death”. That’s a bit long winded so we typically just refer to the ability for an estate beneficiary to carry out a Deed of Variation (DOV) on some or all their inheritance. Deadline wise, a DOV can be made up to two years after a person’s death. Beware, there is no discretion to extend the deadline!
A DOV allows someone who has inherited to give away some or all their entitlement. That might be for altruistic reasons, or (commonly) that inheritance has created or exacerbated the recipient’s potential IHT liability.
1. What paperwork is required?
Strangely it doesn’t have to be a deed. S142 simply instructs us that there is a requirement for an instrument in writing made by the person or any of the persons who benefit or would benefit whether or not administration has been completed. HMRC can accept a letter or note from the beneficiary redirecting their inheritance so long as the document conforms to the guidelines and otherwise meets the conditions of S142. Clearly, best practice would be to take legal advice when carrying out a DOV.
If in doubt, refer to this checklist.
2. Is a DOV possible for someone inheriting via joint tenancy or intestacy?
Yes. A DOV can be effected for an asset which was jointly owned (joint tenancy) basis.
In addition, a DOV can be used by someone benefitting under intestacy rules. In other words, DOVs can be used whether or not the deceased had a valid will.
3. What are the IHT implications?
Where a beneficiary gifts away inherited funds, that loss to their estate will typically be a transfer of value. But, if the S142 DOV conditions are satisfied, that redirection will be treated for IHT purposes as if it had been made by the deceased. And so, the redirection of property is not a transfer of value by the recipient. In other words, that person is not making a gift subject to the seven-year rule. Instead for IHT purposes the gift is treated as having been made by the deceased.
4. Can a trust be created under a DOV?
Yes.
The person varying away his/her inheritance may be reluctant to redirect funds directly to other beneficiaries. That would mean the original beneficiary would have no future access, couldn’t change their mind later, and the recipient would have carte blanche to do whatever they want with the funds. In short, a key component missing would be control.
Contrast that lack of control with a client ‘varying away’ funds into a discretionary trust. The trustees of the trust, who would typically include the client, can accumulate income and can also pay income or capital to a beneficiary, one of whom may be the person varying their inheritance, at their discretion. In short, the trustees decide who benefits, when and how much. Also, the trust can cater for as yet unborn beneficiaries such as future grandchildren.
There are two important tax considerations. Firstly, for IHT purposes it would be treated as if the deceased had set up the discretionary trust meaning that the original beneficiary is not making a chargeable lifetime transfer (CLT). The consequence of this is that the original beneficiary can be a potential trust beneficiary without infringing gift with reservation rules. That’s a considerable bonus.
Secondly, the original beneficiary is the settlor for income tax purposes.
Note that an off the shelf insurance company trust would not be appropriate. The solicitor appointed to deal with the DOV paperwork would typically draft a bespoke trust deed.
5. Who has to agree to the variation?
It is a common misconception that all the estate beneficiaries have to agree to a variation but this is not correct it is only those who are having their inheritance varied that need to agree. Additionally, if the variation will increase the estate’s IHT liability the personal representatives must also sign.
Think of those clients who have inherited within the last two years and who have a potential IHT liability. A DOV might just be in order…
