What does the inclusion of pensions in IHT mean for charitable gifting?

The recent Autumn Budget 2024 announced significant changes to Inheritance Tax (IHT) landscape - with Rachel Reeves announcing the extension of the nil rate band freeze until 2030, limiting the IHT free amount for Agricultural and Business Property Reliefs to £1m, and the inclusion of pensions in IHT calculations from April 2027. 

Fortunately, the IHT benefits of giving to charity remain untouched, however, all three of the above measures mean that individuals and families should potentially rethink their estate planning strategies. With more estates falling within the IHT net, this guest blog from solicitor Ian Bond explains why it will be sensible to explore options to mitigate the IHT payable, and where charitable giving can assist – in particular as this pertains to pensions.

The impact of including pensions in IHT calculations

Starting from April 2027, most unused pension funds and pension death benefits will be included in the deceased person’s estate for IHT purposes. This marks a significant change in legislation as pensions have generally been excluded from IHT calculations. But what does this mean in practice?

By including pensions in the estate value, beneficiaries may face a 40% tax on amounts above the nil rate band. This change is expected to affect around 8% of estates each year, adding an estimated £1.5b to IHT receipts by 2029-30. The introduction may therefore prompt a re-evaluation of succession plans, as the tax advantages of pensions are reduced.

Nominating pension beneficiaries

Individuals have the ability to nominate the benefit of their private pension on death to a chosen beneficiary via a pension nomination form – and many pension scheme administrators (PSAs) will actively ask their members to nominate beneficiaries. This is lodged with the PSA, and therefore pension arrangements don’t go in Wills. The PSA will keep the record of wishes and take them into account when paying pension benefits due on death.

Individuals are not obliged to complete a nomination – however, if they don’t, it will be left to the PSA to decide where the pension goes. This could mean it going to someone that they wouldn’t want; just like if they fail to make a Will.

Who can pensions be left to?

Most “defined benefit*” pension scheme rules set out clear rules that limit who can benefit from the pension, so that any ongoing benefits must go to the surviving spouse / civil partner or, in some cases, someone (usually a minor child) that is financially dependent on the person who died. However, “defined contribution**” pensions are more flexible.

Nominations can be made to anyone to receive any of the pension benefit that remains unused. Often, the beneficiary will be an individual – such as a surviving spouse / civil partner or children - but it can also be a nomination of an organisation. Therefore, individuals are able to leave all or some of their pension benefit to charity, and individuals who have a defined contribution pension, can nominate multiple beneficiaries - combining both people and organisations.

Details of all beneficiaries are set out in the nomination form, which can also specify how the remaining benefits are to be shared out on death (for example, stating that the pension benefit is divided equally between beneficiaries).

What happens when a charity is named a beneficiary in a pension?

When a charity is named as a beneficiary, the share the charity receives is known as a "charity lump sum death benefit". There is no tax charge on the PSA making the payment of a charity lump sum death benefit, and there is no tax charge on the charity receiving the payment, so long as it is used for charitable purposes.

It is important to take appropriate professional advice on making such a nomination as, in certain circumstances, changes to nominations to support a charity of the individual's choice can be done in a tax-efficient manner (read more here). To provide a simple overview, a charity lump sum death benefit for a defined contribution pension works as follows:

1. Eligibility: The pension scheme member must have nominated a registered charity as the beneficiary of their pension pot.
2. Death Before Age 75: If the member dies before age 75, the charity can receive a tax-free lump sum from the pension pot.
3. Death After Age 75: If the member dies at or after age 75, the charity can still receive a lump sum, but it will be subject to income tax.
4. No Dependents: The charity lump sum death benefit is typically available only if there are no dependents of the member (spouse / civil partner and / or minor children).

This allows the member to support a charity of their choice in a tax-efficient manner.

Key take aways

It is welcome news that charity legacy giving through gifts in Wills remains an option for individuals who want to reduce their IHT bill. And now those options to use charities to reduce the IHT payable on death become a consideration for those looking to manage large death benefits within their pensions. Individuals may want to review their circumstances and consider if they should look to altering their pension nominations to include their favourite charities in order to reduce their tax bill.

For charities, it is important to continue to inform supporters of the different options available to them should the they wish to leave a legacy gift, and encourage them access professional advice on their wealth and tax planning to ensure their succession plans meet the individual’s unique requirements. Pensions are regulated products and so, it is important to take appropriate professional advice before making any changes pensions.

And for advisers, it is clear that charitable gifting will continue to remain a crucial part of client conversations – both to ensure client’s wishes are accurately reflected and able to be carried out, and that all options to mitigate the IHT payable are explored.

Ian Bond is a member of the Law Society’s Wills & Equity Committee, a trustee of the Law Society’s independent charity, and a partner at Irwin Mitchell specialising in lifetime and estate planning.

* Defined benefit: usually a workplace pension. Members receive a set amount of benefits, often determined by their salary and length of service rather than the amount paid in.

** Defined contribution: a pension pot based on how much is paid in. Pension contributions are held as investments by the scheme and provide a fund from which pension benefits can be paid. They can be workplace pensions (arranged by employer) or private (arranged by member).