When a person dies, it is possible for the beneficiaries of the estate to change how their inheritance is distributed through a legal mechanism called a deed of variation.
This essentially allows for the intended recipient to divert their inheritance to another person or a Trust, meaning that the diverted funds are not included as part of their own estate, writes Laura Tommis, trust manager at Zedra.
The industry has seen an increase in demand for the use of deeds of variation in trust planning, largely due to significant increases in property prices and simply due to people now living longer.
Beneficiaries of estates tend to be older and financially comfortable, and no longer have financial dependants. Instead, they might be concerned about inheritance tax (IHT) on their personal estate, and any inheritance they would receive exacerbating their own inheritance tax burden.
Although an obvious reaction may be to make financial gifts to loved ones, uncertainty about the future and the increasing cost of elderly care are making the newly retired cautious about making outright gifts in case this leaves them financially vulnerable in years to come.
Additionally, some people have reservations with making absolute gifts to the next generations, having had to witness family wealth fall as assets of divorce or to simply to avoid making gifts to children or grandchildren who may not have sufficient financial maturity.
How does a deed of variation address these concerns?
A trust created by a deed of variation can provide a useful solution to address the above concerns.
Firstly, when diverted into a trust, the funds will not form part of the original beneficiary’s personal estate. Instead, the settlor of the trust for IHT purposes is considered to be the deceased.
Secondly, the original beneficiary can include themselves as a beneficiary of the trust. This is a powerful consideration and not permissible should the original beneficiary be looking to create a standard lifetime discretionary trust.
Being able to approach the trustees for funds in the future, should there be a need for support with care home fees, living expenses or capital expenditure, can give the original beneficiary a further avenue of financial security.
Finally, trusts created by a deed of variation can provide a great degree of flexibility for benefitting ones own family or other named individuals. The original beneficiary can, in addition to themselves, name classes of beneficiaries which may include minors or even individuals yet to be born, such as future grandchildren, and truly take advantage of multigenerational planning.
They can also appoint individuals as beneficiaries who may not, at the time when the trust is created, be ready to receive an outright gift, be it due to age or personal circumstances, so that the trustees can consider distributing funds to them as and when it becomes appropriate.
A word to the wise
Although the benefits to creating a trust by a deed of variation are significant, it should be noted that the documentation to draft the structures are highly technical and, as with any legal documentation, should only be written by suitably qualified advisers.
Additionally, and crucially, according to a probate attorney, the deed of variation must be completed within two years from the deceased’s death. This may sound like an ample timeframe, however, can often prove a rather tight timescale once probate has been secured.
The ongoing administration of a trust created by a deed of variation resembles largely that of a standard lifetime settlement, although some key differences do exist.
Whereas most trusts will benefit from the support of a professional trustee, it is vitally important that the trustees of a deed of variation can provide continuity beyond the original beneficiary’s lifetime.
The overall tax position
For IHT purposes, the gift into trust is considered to have been made by the deceased rather than the original beneficiary. There is no requirement for the original beneficiary to live for a further seven years from the date of the deed of variation in order for the transfer into trust to be disregarded for IHT purposes.
The trust may then be subject to a charge to IHT on every 10th anniversary on distributions from the trust and eventually when the Trust comes to an end with the relevant date for the calculations being the death of the deceased.
By contrast, for capital gains tax (CGT) purposes, the settlor of the trust is deemed to be the original beneficiary and the deed of variation must include a statement by them to enable the trustees to acquire the trust assets at probate value for CGT.
The statement ensures that any dispositions made by the variation are deemed to have been made by the deceased, rather than the original beneficiary.
As you can see, a deed of variation is an attractive way for many to structure their wealth; however expert advice is vital for anyone considering setting up a trust in this way.
This article was written for International Adviser by Laura Tommis, trust manager at Zedra.