The UK Government has announced a change to the tax rules on inherited pensions which could prevent beneficiaries facing an Income Tax bill simply because a pension provider takes more than two years to pay out after someone's death.
The measure, confirmed in Chancellor John Healey's Autumn Budget on Wednesday, removes an existing rule under which certain pension death benefits that would otherwise be tax-free can become taxable if payment is made outside a two-year deadline.
What the Change Means
The change applies to qualifying payments made from October 28, although legislation will be introduced through the Finance Bill 2026-27. According to the official Budget tax documents published on GOV.UK, the measure will prevent pension and lump sum death benefits losing their tax-free status solely because of the time taken to make the payment.
The previous rule generally affected certain benefits following the death of a pension scheme member before the age of 75. Where the conditions for tax-free treatment were met, beneficiaries could normally receive qualifying pension death benefits without paying Income Tax, provided the relevant payment or designation took place within two years.
How the Two-Year Rule Worked
However, payments made outside that period could become subject to Income Tax, even where the beneficiary would otherwise have qualified for tax-free treatment. The two-year period was measured from when the pension scheme administrator first knew, or could reasonably have been expected to know, about the member's death.
Under the new measure, a qualifying payment will no longer become taxable simply because that deadline has passed.
Industry Reaction
Claire Trott, Head of Advice at St. James's Place, welcomed the announcement as one of the less prominent pension changes in the Budget. She said: "Another small but welcome nugget is the removal of the two-year rule on pension death benefits, a hangover from the lifetime allowance regime."
She added: "This means that from Budget Day 2026, income tax will no longer apply simply because benefits are paid more than two years after the member's death. The rule originally ensured that benefits were either tested against the lifetime allowance or subject to income tax where the member died before age 75."
What Still Applies
The UK Government's published tax measures confirmed the change covers both pension death benefits that would otherwise be taxed as pension income and lump sum payments that could have attracted a special tax charge.
Importantly, the change does not mean every inherited pension will be free from tax. Different rules continue to apply depending on the age of the person who died, the type of pension benefit and whether the payment meets the conditions for tax-free treatment.
For example, pension benefits inherited following the death of someone aged 75 or over are generally subject to Income Tax when paid to beneficiaries, depending on how the benefits are taken. Separate limits on tax-free lump sum death benefits also remain relevant.
The measure specifically removes the additional tax consequence arising solely from the two-year deadline, rather than abolishing the wider rules governing inherited pensions. The change applies to relevant payments made on or after October 28, rather than only to deaths occurring from that date. Full details can be found on GOV.UK.
