Earlier this year, I wrote about a seemingly unintended consequence of the forthcoming changes to the inheritance tax (IHT) treatment of pensions. By way of reminder, from 6 April 2027, most unused pension pots will be brought within the scope of IHT and may therefore be subject to IHT at a rate of up to 40% on death. One consequence of this change is its effect on charitable giving, where individuals intend to leave at least 10% of their net estate to charity to benefit from the reduced rate of IHT of 36%.
The government previously confirmed in April of this year that, for the purposes of the IHT reduced rate rules, unused pension funds would form part of the “general component” of an estate. In other words, pensions would be put in the same bucket as an individual’s assets passing under their will (their “free estate”). This would mean that, in order to qualify for the reduced rate of IHT on these assets, an individual would need to give away at least 10% of their free estate and pension funds combined. This was of particular concern to those individuals that had already created a will with a legacy designed to secure the reduced rate of IHT. Where a will leaves 10% of the “general component” to charity, the inclusion of a substantial pension fund could considerably increase the amount passing to charity under the will, despite the pension itself passing outside the will. The increased charitable legacy would then need to be funded from the free estate, to the detriment of the residuary beneficiaries of the will.
However, the government has now changed course, as announced in the Autumn Budget. A separate component for pension funds will now be introduced, allowing those administering estates to decide whether a pension fund should fall within the general component or not. This is a welcome change, providing flexibility for the estates of those individuals generous enough to have left significant amounts to charity. It should also prevent the new legislation silently rewriting the wills of those individuals that have left charitable legacies designed to secure the reduced rate, though the drafting should of course be checked to ensure that it still works harmoniously with the new legislation once this is available.
