What if I don’t want my inheritance?
It is a common misconception that following an individual’s death nothing can be done to alter that person’s Will or alter where assets passing under…
It is a common misconception that following an individual’s death nothing can be done to alter where assets passing under the Will ultimately end up.
However, it is possible to rearrange an interest in an estate so that it is treated as if it was transferred directly from the deceased. This can be done taking into consideration the financial position of one or more beneficiaries and possibly to carry out some post-death tax planning.
In most cases, when a person receives an inheritance via a Will or intestacy (i.e. where there is no Will) or even by survivorship (for a share of jointly owned assets) those assets will necessarily add to and increase the capital value of that beneficiary’s own estate. That beneficiary may not want or need that inheritance and furthermore that inheritance could have both tax implications for the beneficiary further down the line.
So what if you don't want an inheritance? Or what if you're an executor, and a beneficiary doesn't want his/her inheritance? One option would be for the beneficiary to give what he/she has received away to others as a straight gift and that would be treated as either a potentially exempt transfer (PET) or a chargeable lifetime transfer (depending on whether assets were to pass into trust). This could have negative Inheritance Tax (IHT) and/or Capital Gains Tax (CGT) consequences.
Alternatively, the beneficiary could execute a Deed of Variation and redirect all or part of any inheritance he/she receives to another individual or to charity or (if relevant) to a family trust. This could have significant tax advantages. A variation factually is just a gift but Section 142 of the Inheritance Tax Act 1984 provides that the terms of the variation will supersede the terms of a Will or intestacy provided certain conditions are met.
To be effective, the deed of variation must be executed by each of the relevant beneficiaries whose interests under the terms of the Will (or intestacy) are adversely affected by the variation. It is common for those benefiting under the variation as well as the personal representatives to be a party to the deed (although this is not essential in many cases) just so that they are aware of what is being done.
If the Will provides for minor or unborn beneficiaries then it would be impossible for all those adversely affected by the deed to be a party to the document. Any variation in those circumstances would need a court order and it would have to be shown that the deed is in the interests of the minor or unborn beneficiaries.
In terms of the tax benefits of a variation, current IHT and CGT legislation provides that as long as the deed is completed within two years from death and contains a valid election, the provisions of a variation are regarded as if they were those put in place by the deceased. This means that the variation is not treated as a PET or a lifetime chargeable transfer by the beneficiary and can so allow the original beneficiary to create a trust from which he/she can benefit. This provides a valuable and rare exception to the rule which prohibits gifts under a reservation from being outside the estate of the person making the gift.
As an example, Bill received a pecuniary legacy of £200,000 from his late father Ben. As Bill has a large estate of his own and is already thinking about his own IHT planning. He has sufficient assets and income to meet all of his current and future income and capital requirements. He, therefore, decides to redirect his inheritance to his children to help them purchase properties. By using a Deed of Variation created within 2 years of Ben’s death, the legislation treats the £200,000 as passing directly from Ben’s estate to his grandchildren without additional IHT being payable. The result being that Bill’s taxable estate has been reduced immediately by £200,000. Had Bill instead decided to receive his inheritance and then simply gifted the £200,000 to his children that sum would not have fallen out of his estate until he survived the gift by 7 years. If he had kept the legacy himself and ultimately left it to his children, the sum would have been taxed at 40% on his death.
In the same example, Bill may have decided that although he does not need the £200,000 he does not yet trust his children (or their partners/spouses!) enough to receive the inheritance he wants to pass on to them. To maintain a degree of control he could then redirect the £200,000 into a trust. Bill would not be regarded as the person establishing the trust for IHT purposes but he would be for CGT and income tax purposes. This means that any income and capital gains in the trust will be taxed at Bill’s tax rates. This may be a small price to pay for the control which he desires.
Other circumstances where a Deed of Variation could be used to save tax:
- Where a parent leaves an inheritance to a child or children when there is a surviving spouse. The children could redirect the gift to the spouse so that the estate becomes eligible for spouse relief and passes tax free.
- To give money to charity to reduce an estate’s overall tax charge or by giving 10% or more of the net estate to charity so that the whole estate benefits from the lower 36% rate of tax.
- To redirect the deceased’s share in a house to descendants so as to benefit from the residential nil rate band allowance.
As Deeds of Variation provide significant opportunities to mitigate tax, their use is subject to periodic political scrutiny. In the past, for example, the tax benefits of variations have been the subject of potential attack according to the pre-election manifesto of the Labour party. In 2015, the Government reviewed the tax planning uses of Deeds of Variation but decided against any changes to legislation and only to “monitor” the position for now.
Whilst the shelf life of Deeds of Variation may therefore not be unlimited, for those in the fortunate position of not needing inherited assets immediately, they do provide a very useful tool to review the position following a death. If need be arrangements can be altered to be more tax-efficient and to allow the next generation to inherit earlier than otherwise would be the case.