Inherited Pensions: The Two-Year Rule Has Gone - What It Means for Beneficiaries

If someone dies before 75, their pension can usually be passed on tax-free. Until the 2026 Budget, that could be lost if the money was paid out more than two years after the death. That rule has now gone for payments made on or after 28 October 2026. Our earlier article on inheriting a pension described the two-year rule as it applied before the Budget, so this article explains what’s changed.

What the two-year rule used to do

Under the old rules, a pension paid out after a death before 75 was normally free of Income Tax for the beneficiary - but only if it was paid within a two-year window. Miss that window, and the payment could become taxable at the beneficiary’s own rate, even though nothing else about the situation had changed.

In practice, delays weren’t always anyone’s fault. A scheme might not hear about the death for months, paperwork could take a long time, or a beneficiary might not know the pension existed - something old and forgotten pensions make all too common.

What’s changed

The Budget removes the two-year rule, so that “beneficiaries will no longer be taxable solely because tax-free pension and lump sum death benefits are paid more than two years after the member’s death”. This applies to any payment made on or after 28 October 2026, even where the death happened earlier. It will be legislated in the Finance Bill 2026-27.

So if a payment is still waiting to be made after a death before 75, and it would have been tax-free inside the old window, it shouldn’t now become taxable just because it’s being paid late.

What hasn’t changed

• The age at death still matters. If the person died at 75 or over, the beneficiary still pays Income Tax at their own rate on what they draw, as before.
• Tax-free lump sums still count towards the lump sum and death benefit allowance. The Budget also changes how tax is assessed and collected when that allowance is exceeded, to give beneficiaries more certainty, but the allowance itself is unchanged.
• The Inheritance Tax change still goes ahead. From 6 April 2027, most unused pension funds and death benefits will count towards the value of an estate for Inheritance Tax, with spouses and civil partners still exempt. Nothing in this Budget changes that.
• Nominations still matter. Who receives the pension is usually decided by the scheme, guided by the expression of wishes form, so keeping that form up to date is as important as ever.

Should beneficiaries still notify the scheme quickly?

Yes, for different reasons. Telling the scheme promptly is no longer about protecting the tax-free treatment, but delays can still:

• leave the money sitting uninvested, or invested in a way that doesn’t suit you
• hold up the estate, particularly once pensions start counting for Inheritance Tax from April 2027, when the executors will need the pension values to work out the bill
• make it harder for the scheme to decide who should receive the money if circumstances have changed

A related change: terminal illness

The Budget also widens the definition of terminal illness for pension purposes, making it easier for people who are terminally ill to access their pension savings early. It will also allow medical evidence from doctors registered overseas.

What to do if you’re affected

• If you’ve already been taxed on a payment made on or after 28 October 2026 purely because of the two-year rule, ask the scheme administrator how they’re applying the change.
• If you’re waiting for a payment from the pension of someone who died before 75, the delay alone should no longer make it taxable.
• If you’re planning your own estate, our Budget 2026 round-up covers the other changes, and the April 2027 Inheritance Tax change remains the bigger issue.

The bottom line

Removing the two-year rule takes away a tax trap that could catch beneficiaries out through no fault of their own. Pensions inherited from someone who died before 75 stay tax-free when paid late, from 28 October 2026. The rest of our earlier advice still stands: keep nominations up to date, notify schemes promptly, and plan for pensions coming into Inheritance Tax from April 2027.