The coronavirus pandemic and the fundamental way in which it has changed everyone’s lives so unexpectedly and so quickly means that more people than ever are thinking about their personal circumstances.
This has included families deciding that this is the time to review the division of an inheritance from a deceased relative or friend. There may be several reasons why you might want to look at how an inheritance has been bequeathed:
How does Inheritance tax work?
Upon their death, each individual is taxed at a rate of 40pc on all their assets above a threshold of £325,000.
Things subject to the tax:
- Life insurance pay-outs
An exemption for a “family home allowance” applies to a family home going to direct descendants only. Ultimately, this means that married couples will be able to use their combined allowances to pass estates worth up to £1m onto their direct descendants.
In the 2018-19 tax year this was worth £125,000, £150,000 in 2019-20 and £175,000 in 2020-21.
People who sell an expensive property will be eligible for an “inheritance tax credit” so can still qualify for the new threshold, as long as most of the estate is left to descendants.
What is a ‘deed of variation’?
A deed of variation – or DOV – is a legal document that allows the beneficiaries of an estate (e.g. children) to make changes to a will, in the name of the deceased, after their death.
You can change a will to:
- reduce the amount of Inheritance or Capital Gains Tax payable
- provide for someone who was left out of the will
- move the deceased’s assets into a trust
- clear up any uncertainty over the will
This means that, if someone has not written their will in the most tax-efficient way, if they have inadvertently left someone out of their will, or if they have not written a will at all, the beneficiaries are able to redirect the money they stand to inherit to other parties.
In the case that you are about to inherit a windfall that will take your own estate over £325,000 you can alter the deceased’s will so that money you stand to inherit passes directly to other beneficiaries, reducing or eliminating the amount of tax you would otherwise have to pay later.
For example, you may want to redirect some of the money you stand to inherit to charity, or to your grandchildren via discretionary trust for their benefit later on.
What are the rules?
Any deed of variation must be drawn up within 24 months of the death of the deceased, and must be signed by all the executors and beneficiaries of the estate to be valid.
A DOV is separate from a grant of probate – the legal document that allows you to gather up and distribute the assets of the deceased – and can be obtained before or after probate is granted.
There are no formal documents to apply for, you can simply write a letter explaining the changes you wish to make. However, you must ensure the letter meets certain conditions – HM Revenues & Customs provides a checklist.
Provided everyone else involved agrees, you can redirect your inheritance to anyone you wish, even if they are not named in the deceased’s will.
Although you may be the one deciding what changes to make, through a DOV the changes are made in the name of the deceased as if they were making the changes themselves.
What if there is no will?
When someone dies without leaving a will, their estate is passed on to their next of kin, usually a spouse or other immediate family member, in line with the so-called rules of intestacy.
However, the rules state that certain family members cannot inherit. Unmarried partners, step children, and other relatives and friends, irrespective of the role they played in the life of the deceased, will not be gifted anything.
If you, and others, have inherited assets from someone who has died, any of these circumstances might prompt you to choose to vary the terms of the will. If you are a beneficiary under an intestacy – in other words where there was no will – you can also change the way the intestacy provisions work. Although the intestacy provisions changed in February 2020, the intestacy rules governing the distribution of an estate to the closest living relatives have not altered. These rules can have unforeseen consequences, particularly if the deceased person had a partner but was neither married nor in a civil partnership.)
A DOV can still be used if there is no will, allowing you to redirect money to other beneficiaries that would otherwise have been left with nothing.
How is it done?
The variation must be in writing and, although HM Revenue & Customs suggest a letter would suffice, a formal deed is usually prepared. There are many strict conditions to be met for a Deed of Variation to be valid. Some examples are:
- the variation must be made within 2 years of the death;
- it must clearly identify the part of the estate being varied, and who is to benefit from the variation;
- it must be signed by all the beneficiaries who ‘lose out’ by the variation;
- it must include a statement, in a prescribed form, that the beneficiaries intend the variation to be effective for IHT and/or Capital Gains Tax (CGT) purposes.
- It is effective from date of death and IHT is worked out taking account of the variation. For CGT purposes, the beneficiaries are treated as acquiring assets at their date of death value and not their current value.
The Future of Deed of Variation?
A deed of variation is a safety net when it comes to protecting your inheritance. Considering the government’s need to collect IHT to help plug the deficit, it is reasonably foreseeable that their tax efficient status may result in their abolition.
If you want to ensure that your assets pass to those who you choose, it would be an advisable time to review your current will(s) and to make sure that they are still as tax efficient as possible.
Professional advice at this time can help to alleviate the problems which may no longer be able to be cured should the current safety net of Deeds of Variation disappear.
Further information in available from ….
Get in touch with JMS Accounting via our contact page if you need further advice on Inheritance tax planning.