UK discretionary trust by deed of variation

26 June 2024

In the UK, a deed of variation made within two years of the date of death can be used to secure valuable Inheritance Tax (IHT) and Capital Gains Tax (CGT) benefits.

If you are the beneficiary of an estate when someone has died, you can choose to benefit in accordance with the Will, or let someone else benefit in your place – perhaps your children or a charity.

What is a discretionary trust by deed of variation?

A deed of variation is a legal document that ‘redirects’ a beneficiary’s interest in an estate. It is then possible to set up a discretionary trust to receive the interest, providing further flexibility.

A beneficiary has two years from the date of the death to create a trust in this way. Under English law, the trust can then last for up to 125 years, allowing for generational wealth planning.

For IHT purposes, the settlor for the trust is the deceased, but for CGT purposes the settlor for the trust is the original beneficiary.

If a variation creates more than one trust, the trusts will be treated as related settlements created by the same settlor (the deceased) and starting on the same day (date of death) so they will share one nil-rate band between them for trust IHT and exit charge purposes.

It is important to note that all the individuals affected by a variation must agree to it, and you cannot change someone else’s inheritance without their consent.

Why create a discretionary trust by deed of variation?

Creating a discretionary trust by a deed of variation presents a unique opportunity to place funds in trust in a relatively tax efficient manner. A discretionary trust can be created for a variety of reasons such as:

  • Enabling the original beneficiary under a Will to remain a potential beneficiary of the trust, without the trust funds being considered a part of their own estate for IHT purposes.
  • Flexibility over who will receive the trust assets, and when.
  • Tax planning, particularly in relation to IHT.

Who can be beneficiaries of a discretionary trust by deed of variation?

In addition to enabling the original beneficiary under the Will to be a beneficiary of the trust, it is usual to name a range of other beneficiaries by referring to them by class such as ‘children, their spouses, grandchildren and remoter issue’.

It is not necessary to name individual beneficiaries and thus people born into those classes at a later date will be included automatically as potential beneficiaries of the trust.

Beneficiaries can also be added or removed at any time and the discretionary nature of the trust means that the trustees decide how much and when a beneficiary may receive from the trust fund.

What is the impact on Inheritance Tax?

Where a discretionary trust is created using a deed of variation, the gift into trust is for inheritance tax purposes considered to have been made by the deceased on their death rather than as a gift made by the original beneficiary.

The original beneficiary of the estate is not required to survive an additional seven years from the date of the variation for the gift into the trust to be exempt from IHT,

As the trust is deemed to have been created by the deceased for IHT purposes, rather than the original beneficiary, there is no IHT liability on the death of the original beneficiary. Similarly, there is no charge against the Trustees on the death of any other beneficiary of the trust either.

The trust may be subject to an IHT charge on every tenth anniversary of the death of the deceased, on the payment or transfer of assets out of the trust, and eventually when the trust comes to an end. However, if the estate of the deceased was not liable for inheritance tax, it is unlikely that the trust will attract any liability. If there was any liability to IHT, this would be calculated at the lower rate applicable to trusts than which applies at a person’s death.

In summary

As outlined above, there are a number of benefits to creating a discretionary trust by deed of variation, but careful consideration should always be given to your specific circumstances when considering estate and inheritance tax planning.

How ZEDRA can help

Our experts are a safe pair of hands if you are seeking to future-proof your estate planning and handle your affairs with the sensitivity they deserve. For more information on any aspect of UK trusts or to receive personalised guidance in respect of creating a discretionary trust by deed of variation, get in touch with Laura Tommis.

Zedra Trust Company (UK) Limited is authorised and regulated by the Financial Conduct Authority.

The information provided should not be considered to constitute investment advice, trusts and trustee services is not a regulated activity and Zedra Trust Company (UK) Limited does not provide Legal or Tax Advice.

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