Major changes to pensions and inheritance tax from April 2027: implications for charitable giving

Analysing the impact of the draft Finance Bill 2025-26 on pensions, estates, and gifts to charity

Introduction: a new era for pensions and Inheritance Tax

Sweeping changes to the inheritance tax (IHT) treatment of pensions and death benefits are on the horizon. From 6 April 2027, under provisions in the draft Finance Bill 2025–26 (still subject to parliamentary approval), unused pension funds and lump-sum death benefits will largely fall within the IHT net. It's easy to overlook the significance of this because there has been much media focus and campaigning about the changes to agricultural and business property relief for IHT (which you can read more about here), but these reforms will have far-reaching implications for individuals, families, personal representatives and advisers.

This article explores:

• The current position
• What’s changing in 2027
• How charitable giving and the reduced IHT rate will be affected
• Practical steps for estate planning.

Current law: pensions outside the estate

Under existing rules, most unused pension funds and lump-sum death benefits under registered pension schemes do not form part of the deceased member's estate for IHT purposes. This is largely due to the discretionary trust structure employed by the majority of modern pension schemes. When a member dies, the scheme trustees or administrators exercise discretion over who receives the death benefits, meaning that the member never had a fixed entitlement to the funds. As a result, the value of these benefits typically falls outside the scope of IHT, making pensions a valuable tool in estate planning and wealth preservation.

The 2027 changes: pensions brought within the IHT net

From 6 April 2027, under provisions set out in the draft Finance Bill 2025-26, most pension death benefits and unused pension funds will be brought within the deceased's estate for IHT purposes. Unless an exemption applies, these sums will be aggregated with the rest of the estate and potentially taxed at 40%.

It is essential to note that these changes are still in draft form and may be subject to further consultation and revision.

Double tax for beneficiaries

In addition, clients and their beneficiaries need to be aware that inherited pensions may also incur income tax (up to 45%) upon drawdown, leading to a combined effective tax rate of 64% to 67%, or even higher for large estates. The net rate varies based on the beneficiary’s tax bracket and whether the deceased was over 75. For those that die over the age of 75, beneficiaries of the pension will need to pay income tax (at their own marginal rate) on drawdowns. This additional layer of tax is not applicable to non-pension inherited assets with the result that we are now in a position whereby those over the age of 75 should often be encouraged to divest themselves of their pension in priority to other assets. A complete reversal of previous advice!

Charitable giving and the 10% test

Charitable giving has long been incentivised through favourable IHT treatment. Under the current system, if at least 10% of an individual's net estate is left to charity, the IHT rate on the rest of that person's estate is reduced from 40% to 36%. This is known as the "10% test" and encourages philanthropy by offering a tax saving on death.

The calculation of the 10% test is complex. The estate is divided into three “components” (settled property, survivorship, and general) and the test is applied separately to each component. The value of charitable gifts in each component is compared to 10% of the “baseline amount” (essentially, the value of the component after deducting debts, exemptions, and reliefs). If the threshold is met in a component, the reduced 36% rate applies to that component.

The inclusion of pension funds in an estate raises important questions about the 10% test – will pensions fall into the general component or form a new category? How will this affect achieving the 10% threshold? 

The draft legislation does not appear to create a separate component for pensions. On that basis, if the rules are enacted in current form, we would expect pensions to fall within the 'general component'. This means that clients who want to access the 36% rate of IHT will need to be comfortable with a sum passing to charity that is equivalent to 10% of the aggregate value of both (a) their unused pension, and (b) their free estate assets (excluding those jointly owned). 

Clients and advisers will need to review Wills and beneficiary nominations to ensure that charitable gifts remain effective and, where appropriate, that the 10% threshold is achieved in each relevant component. 

Charity exemption confirmed

What is certain is that, whether the 10% test is met or not, gifts made to charity from pensions on death will be exempt from IHT. The draft legislation specifically addresses this and confirms that the longstanding exemption from IHT for property passing to a UK-registered charity will be extended to pensions.

Practical implications

For individuals with significant pension savings:

• Review estate plans that relied on pensions being outside the IHT net
• Consider whether pension funds should form part of charitable gifts
• Update Wills and beneficiary nominations once the rules on the 10% test are confirmed.

Conclusion: the need for ongoing review

The inclusion of pension death benefits within the IHT net from April 2027 marks a significant shift in tax policy. While the exemption for gifts to charity is preserved (and extended to pensions), the loss of the general IHT exemption for pension funds means that careful planning is more important than ever. Both clients and advisers should keep abreast of legislative developments, review their estate plans in light of the new rules, and seek specialist advice where necessary. The draft Finance Bill 2025-26 is not yet law, and the final shape of the reforms may change - but the direction of travel is clear, and early preparation will be key to safeguarding family wealth and supporting charitable causes.