Israel, which says it will ban UNRWA operations in the country from late January, accuses the agency of being involved in the October 7, 2023, Hamas-led attacks on Israel that triggered the 14-month-old war in Gaza.
"The government's core support to UNRWA ends," the Swedish foreign ministry said in a statement.
Sweden's decision was in response to the Israeli ban, as it will make channelling aid via the agency more difficult, the country's aid minister, Benjamin Dousa, told Swedish broadcaster TV4.
The new Israeli law does not directly ban UNRWA's operations in the West Bank and Gaza but it will have a severe impact on UNRWA's ability to work.
Top UN officials describe UNRWA as the backbone of Gaza's aid response.
Sweden plans to increase its overall humanitarian assistance to Gaza next year to 800 million Swedish crowns ($A116.20 million) from 451 million Swedish crowns spent this year, the foreign ministry said.
Aid will flow via several organisations including the UN World Food Programme, the UN Children's Fund, the UN Populations Fund and the International Committee of the Red Cross, the ministry added.
The Palestinian embassy in Stockholm said in a statement: "We reject the idea of finding alternatives to UNRWA, which has a special mandate to provide services to Palestinian refugees."
The refugee population relies on UNRWA healthcare, education, emergency relief and humanitarian assistance, it said.
The United Nations General Assembly threw its support behind UNRWA this month, demanding that Israel respect the agency's mandate and "enable its operations to proceed without impediment or restriction".
The decision by the Government of — Philippe Lazzarini (@UNLazzarini) #Sweden to stop funding @UNRWA in 2025 is disappointing and comes at the worst time for Palestine Refugees. The decision is one day after the members of the UN General Assembly overwhelmingly adopted a resolution in support of UNRWA. Sweden…December 20, 2024
UNRWA chief Philippe Lazzarini said on X: "Defunding UNRWA now will undermine decades of Sweden's investment in human development including by denying access to education for hundreds of thousands of girls and boys across the region."
Israeli Deputy Foreign Minister Sharren Haskel thanked Dousa for a meeting they had this week and for Sweden's decision to drop its support for UNRWA.
"There are worthy and viable alternatives for humanitarian aid, and I appreciate the willingness to listen and adopt a different approach," she said.
The UN has said nine UNRWA staff may have been involved in the October 7, 2023 Hamas attack and had been fired.
A Hamas commander in Lebanon - killed by Israel - was also found to have had a UNRWA job.
