Most people reading this will already be aware of the broad direction of travel. From 6 April 2027, unused pension funds are expected to become subject to inheritance tax as part of a deceased person’s estate, following the draft legislation and technical notes published by the government and HMRC.
That alone represents a major shift in UK estate planning.
For years, pensions have often sat outside inheritance tax calculations entirely. In many cases they have been one of the more tax-efficient assets to pass between generations. The proposed changes alter that position significantly and may force people to rethink which assets they spend, preserve or ultimately leave behind.
One area which has perhaps received less attention is the knock-on impact on charitable giving and the reduced 36% inheritance tax rate.
The lesser-known “10% rule”
Many people know the standard inheritance tax rate is 40%.
Fewer realise there is a reduced rate of 36% available where at least 10% of the relevant estate is left to charity.
The rules themselves are not new. What changes from 2027 is the likely interaction with pensions.
HMRC has now confirmed that unused pension funds and death benefits will form part of the “general component” of the estate for the purposes of calculating whether the 10% charitable threshold has been met.
The government technical note confirming this can be found here:
HMRC technical note on inheritance tax on pensions
In practical terms, pensions are not simply becoming potentially subject to inheritance tax. They also increase the size of the estate against which the 10% charitable calculation is measured.
That may create situations where an estate which previously qualified for the 36% rate no longer does, unless charitable legacies are reviewed.
Equally, some people may now deliberately use charitable giving more strategically as part of inheritance tax planning once pensions are brought into the estate calculation.
The double taxation issue
The bigger planning discussion, in my view, is the increasing possibility of pension assets suffering both inheritance tax and income tax.
Historically, pensions often escaped inheritance tax entirely. Beneficiaries might still pay income tax depending on the age of death and how benefits were drawn, but inheritance tax was frequently avoided.
Post-2027, that position may change substantially.
Where death occurs after age 75, inherited pension benefits are already typically subject to income tax in the hands of beneficiaries when withdrawn. If the pension itself also becomes subject to inheritance tax within the estate, the overall effective tax rate on some pension assets could become very high indeed.
This changes the planning conversation.
The long-standing assumption that pensions are automatically the “best” assets to preserve for inheritance tax purposes becomes less certain if both inheritance tax and income tax apply.
Why charities may become more attractive in pension planning
One interesting consequence is that charitable beneficiaries may become significantly more attractive for pension assets specifically.
Where pension death benefits are paid to a registered charity, they can generally pass free of inheritance tax and free of income tax.
That creates a potentially powerful planning opportunity, particularly where death occurs after age 75.
In simple terms, pension funds left to adult beneficiaries after age 75 may face:
- inheritance tax within the estate; and
- income tax when drawn by the beneficiary.
The same pension funds left to charity may avoid both entirely.
For clients already considering charitable giving, that becomes a far more compelling discussion than it may have been historically.
It may also influence which assets people leave to family and which assets they leave to charity. In some situations, leaving pension assets to charity and other assets to family could produce materially different outcomes from a tax perspective.
This does not mean everybody should suddenly redirect pension wealth to charity, nor does it mean pensions become poor planning tools overnight. There are still many situations where pensions remain highly valuable from both retirement and estate planning perspectives.
There is also the knock-on implication that wills drafted before the new pension rules may become inappropriate: where a 10% gift has been made, depending on the wording used, the monetary value of that gift may radically increase. Equally, if it does not increase it may fail to qualify under the new rules.
The point is that the planning landscape is changing; and both estate and financial plans may need to be reviewed.
The interaction between pensions, inheritance tax, charitable relief and income tax is becoming much more interconnected than it was previously. For advisers, solicitors and clients alike, this is likely to become an increasingly important area of discussion over the next couple of years.
At the time of writing, we still have draft legislation rather than fully enacted law, and there may yet be amendments or technical refinements before April 2027.
The trajectory, however, now appears fairly clear – this is the most significant change to both pensions and inheritance tax in many years.
