A variation can redirect assets inherited by a will or intestacy. It’s one of the first pieces of planning that should be looked at when assessing an individual’s taxable estate.
If a person has received a legacy within the past two years, then they will normally be able to redirect it, including into a discretionary trust, with themselves as a potential beneficiary. This would immediately remove the asset from their own estate for inheritance tax purposes, but can – where the legacy is varied into a discretionary trust with the individual within the beneficial class – retain potential access.
A legacy can also be disclaimed and will then be redistributed in accordance with the will/intestacy. The individual disclaiming the inheritance will have no say over who receives their disclaimed legacy.
Varying a legacy
Inheritances are usually gratefully received, and can provide a life-changing opportunity, such as a house deposit or the prospect of paying for further education. However, if the recipient already has a large personal estate the inheritance can compound their existing IHT liability.
It is possible, within two years of the deceased’s date of death, to undertake variation to remove part or all of the inheritance from the recipient’s estate immediately without any loss of accessibility.
The person making the variation may retain access to the assets, thereby preserving their financial security, without them being considered part of their estate. This is achieved through the use of a discretionary trust, where the recipient who is varying the assets is within the class of beneficiaries (see Box 1).
Alternatively, the recipient may wish to make a gift of the inheritance directly to another individual. The suitability of such actions will depend on affordability and accepting loss of control of the asset.
A variation can be applied for IHT alone, capital gains tax alone, or both. The person varying the legacy needs to specify which tax(es) the variation is effective for. The variation is then read back to the date of death for that tax, meaning the deceased is considered to be the settlor of any trust set up by a variation for IHT and/or CGT purposes.
However, a variation cannot be applied for income tax purposes. This means that where a person redirects their inheritance, they are considered the settlor for income tax purposes. There are three common situations where this will be relevant:
- Where the variation is into a trust where the original beneficiary is included in the classes of beneficiaries, it is a settlor-interested trust for income tax purposes. All trust income will be assessed against the settlor’s tax position.
- Where a trust set up by variation invests in an investment bond, the person making the variation will be considered the settlor for income tax purposes. Any tax on chargeable events within their lifetime will be assessed against their income tax position (see Box 2).
- Where a parent redirects their inheritance to a bare trust for their minor unmarried child, the parental settlement rule will apply on income received within that trust.
A valid variation must meet the following requirements:
- It must be made within two years of death.
- It must be signed by all people detrimentally affected by the variation. Where these are minors, court approval is likely to be needed.
- The variation must clearly identify what is being varied and who will benefit.
- It must contain a stamp duty certificate if it alters the destination of stocks, shares or marketable securities.
- To be effective for IHT and/or CGT purposes, the variation must contain a statement that cites the appropriate statutory references.
- The original beneficiary cannot receive anything in return for varying their inheritance.
A variation doesn’t have to be done by deed – it can be a simple letter, provided it meets the conditions. HMRC has published a useful ‘Instrument of variation’ checklist for a taxpayer to establish if a variation is effective for IHT and/or CGT purposes. Where the client is in any doubt over the validity of a variation, they should seek legal advice.
If the variation results in more IHT being payable – for example, where a spouse is passing their entitlement on to a child – or if it affects the IHT due on another estate, a copy of the deed must be sent to HMRC within six months of it being written.