Two-year tax rule on inherited pensions scrapped: what bereaved families need to know

The essentials: The UK government has scrapped the two-year rule that could turn tax-free pension death benefits into taxable income when a payment was late. Announced in the Budget on October 28, 2026, the change applies to payments made on or after that date and will be written into the Finance Bill 2026-27. It follows delays at the Civil Service Pension Scheme that left bereaved families facing possible tax bills.

What was the two-year rule?

When a pension saver dies before 75, lump sum death benefits are normally tax-free. There was a condition, however: under the old rule, HMRC says, the scheme administrator had to pay within two years of learning of the death.

Miss that window and the money became taxable. Individuals paid income tax through PAYE, at their marginal rate according to Civil Service World. Payments to a trust or an estate faced a flat 45% charge. The rule applied however the delay arose, which PensionBee says left families exposed to problems with probate or paperwork they could not control.

What changes from October 28, 2026?

Member died before 75	Before Budget Day	From Budget Day
Paid within two years	Tax-free	Tax-free
Paid after two years, to an individual	Taxed as income	No tax for missing the deadline
Paid after two years, to a trust or estate	45% charge	No tax for missing the deadline

Source: HMRC policy paper, October 28, 2026.

HMRC says the removal also covers income withdrawals and annuities paid to beneficiaries from drawdown funds, and funds designated into drawdown under overseas schemes.

Two limits remain. The tax-free treatment still applies only where the member died before 75. And Royal London notes that the lump sum and death benefit allowance is unchanged at £1,073,100.

Why did the government act now?

Civil Service World links the change to the crisis at the Civil Service Pension Scheme, where the Cabinet Office is working with the administrator, Capita, to clear the oldest outstanding cases.

Earlier in October, Cabinet Office minister Sally Jameson said neither her department nor the administrator “has statutory discretion under tax law to alter or waive these tax charges”. She also said: “Where administrative delays by the scheme lead to an avoidable tax charge, beneficiaries will not be left out of pocket.”

Pensions minister Torsten Bell said the change would “make the position fairer for all grieving families and friends”, adding that “removing the tax deadline does not remove their wider duties”.

Sir Geoffrey Clifton-Brown, who chairs the Public Accounts Committee, was more cautious. He said it would “go some way to reassuring civil service members caught up in an avoidable crisis”, but that “this announcement is not to absolve Capita from processing and making payments”.

How much will it cost, and who is affected?

HMRC puts the cost to the Exchequer at £5 million in 2026-27, then £15 million a year from 2027-28 to 2031-32. None of the documents we read gives the number of families affected.

For the industry, HMRC expects a one-off cost for training and updated guidance, with no ongoing cost. It says an estimated 4% of schemes that pay lump sum death benefits will see a negligible impact.

Becky O’Connor of PensionBee called the removal of the rule “a welcome fix”.

Does this change inheritance tax on pensions?

No. The two-year rule concerns income tax. The plan to bring pensions into estates for inheritance tax from April 2027 goes ahead, and it is a separate measure from the wider Budget announcements.

Royal London does flag a related technical change: the Finance Bill will let a “prospective personal representative” direct scheme administrators to pay inheritance tax due, a power it says currently extends only to a confirmed personal representative or a beneficiary, from April 2027.