Adam Creasey, senior associate, and Emma Sinclair, trainee solicitor, at Stevens & Bolton, examine how the April 2027 inheritance tax changes for pensions could have unintended consequences for charitable giving.
As advisers will know, from 6 April 2027, the majority of unused pension funds and pension death benefits will fall within the scope of inheritance tax (IHT). Currently, pensions generally sit outside an individual’s estate for IHT purposes, but the upcoming changes will subject them to IHT at a rate of up to 40% on death. This tax charge will be in addition to any income tax payable when the nominated pension beneficiaries access the funds.
There are various practical concerns around how pensions will be administered on death, and HMRC recently published a technical note on the reforms which provides greater detail on how the changes will work in practice. However, a key concern that should not be overlooked is the impact on charitable giving. Existing wills with charitable legacies should be reviewed to ensure that the gifts still take effect as intended, and that the pension changes are not silently “rewriting” the will.
What has changed and why it matters
The IHT rules currently offer a reduced rate of IHT of 36% (rather than 40%) for individuals that (broadly speaking) leave 10% of their net estate to one or more UK charities. Many philanthropic individuals minded to secure the reduced rate may have previously been advised to include a charitable legacy in their will, and it is common for these legacy clauses to be drafted so that the amount passing to charity is exactly equal to the qualifying threshold. This is usually done by referring to a specific definition in the IHT legislation whereby the individual leaves 10% of the “general component” of their estate to charity.
The “general component” includes all assets passing under the will (known as the individual’s “free estate”). It does not generally include assets that pass outside of the will such as jointly-owned property and trust property, which fall into separate components under the IHT rules. As charitable legacies are made in a will, and will therefore be paid out of the individual’s free estate, they often specify that the legacy is equal to 10% of the general component (only), as this is the component from which the gift to charity is being made.
However, HMRC’s technical note has now confirmed that, from 6 April 2027, unused pension funds will form part of the general component for IHT purposes. As a result, individuals with significant pension pots may now be giving away considerably more to charity than they might have intended when they prepared their will. To take a simple example:
- Tim has a free estate worth £2m and a pension pot which is also worth £2m.
- Tim leaves a legacy to charity in his will equal to 10% of the general component of his estate.
- The amount passing to charity will depend on when Tim dies:
- Before 6 April 2027: Tim leaves £200,000 to charity (10% of his free estate).
- On or after 6 April 2027: Tim leaves £400,000 to charity (10% of his free estate and pension pot combined).
It’s worth noting that the full amount under the legacy will still be paid out of the free estate (and not the pension fund), leaving less for the residuary beneficiaries under the will.
Taking another example, what if an individual has left a specific amount to charity in their will, having calculated that this was more than 10% of their estate at the time they made their will? They may find that this amount is no longer sufficient to meet the 10% test once they have taken into account the value of their pension.
What you should be doing now
Ahead of the changes coming into effect, individuals and their advisers should consider the following steps ahead of the changes coming into effect.
Firstly, any existing wills containing a charitable legacy designed to secure the reduced rate of IHT should be revisited to ensure that the interaction with pensions is clearly understood. Individuals may decide that, when looking at the value of their assets and pensions in the round, giving away the necessary 10% to charity may now be more than they ever intended to donate. If the will no longer matches their intentions, it should be updated.
Advisers and individuals should also revisit pension nomination forms. As pensions move into the IHT net, it’s increasingly important to ensure that pension nominations are up to date and that individuals understand the IHT consequences of their nomination. For example, on a first death, individuals may want to ensure that their pension passes to their spouse in order to claim the spouse exemption to IHT.
While the pension changes are not yet in force, April 2027 is fast approaching, so it’s essential that individuals and advisers put these preparatory steps into action now. This will put them in the best position to navigate the changes successfully when the time does come.
By Adam Creasey, Senior Associate, and Emma Sinclair, Trainee Solicitor, at Stevens & Bolton
