What Budget 2026 announced
Budget 2026 announced the removal of the two-year rule for pension and lump-sum death benefits. The accompanying Overview of Tax Legislation and Rates (OOTLAR) says that a tax-free benefit will no longer become taxable solely because it is paid more than two years after the pension scheme administrator first knew — or could reasonably have been expected to know — of the member’s death.
The proposal covers cases where the delayed payment would otherwise be taxed as the recipient’s pension income and cases where the special lump-sum death-benefits charge would otherwise apply.
When is the change intended to apply?
The announced effective date is 28 October 2026, for payments made on or after that date. The Budget and OOTLAR also state that the change will be introduced through Finance Bill 2026–27.
This distinction matters. The policy has been announced, but the final legislation must complete the parliamentary process. Executors and beneficiaries should not disregard the current law, scheme instructions or professional advice while the legislation is being enacted.
This does not make every death benefit tax-free
The measure removes one possible reason for a tax charge: payment outside the relevant two-year period. It does not say that every pension or lump-sum death benefit is tax-free.
The tax position can still depend on the type of benefit, the member’s age at death, the recipient, the payment date and whether sufficient lump sum and death benefit allowance is available. Ask the scheme administrator to identify the benefit being paid and explain the treatment it is applying.
Income Tax and excess lump-sum death benefits
Budget 2026 separately announces a new process for collecting tax where the available lump sum and death benefit allowance has been exceeded.
The OOTLAR says that, where a member died before age 75 and the available allowance is exceeded, the excess will no longer be treated as the individual beneficiaries’ pension income. Instead, HMRC will raise a charge against each beneficiary on their share of the excess by reference to that beneficiary’s marginal Income Tax rate for the tax year in which the lump sum was paid.
This is separate from removing the two-year rule. A payment may cease to be taxable merely because of delay yet still face tax for another reason, including an allowance excess.
The lump sum and death benefit allowance still matters
The lump sum and death benefit allowance limits the tax-free treatment available for certain lump sums paid during life or following death. Removing the two-year rule does not remove that allowance.
Executors and beneficiaries should ask the scheme administrator:
- what type of death benefit is being paid;
- how much of the deceased’s allowance is available;
- whether any part of the payment exceeds that allowance;
- who is responsible for reporting or paying any resulting tax; and
- whether the scheme’s position may change when Finance Bill 2026–27 is enacted.
Inheritance Tax changes from 6 April 2027
Inheritance Tax is separate from the Income Tax treatment of a pension death benefit.
The OOTLAR confirms that most unused pension funds and pension death benefits will be brought within the value of a person’s estate for Inheritance Tax purposes from 6 April 2027. It also announces a mechanism allowing a prospective personal representative, where the conditions are met, to direct a pension scheme administrator to pay Inheritance Tax to HMRC.
The OOTLAR also addresses the interaction where both Income Tax and Inheritance Tax apply. Executors dealing with a death on or after 6 April 2027 should coordinate pension information with the estate’s Inheritance Tax reporting rather than treating the pension as automatically outside the estate.
Practical checklist for executors
- Identify every pension scheme and notify each administrator promptly.
- Record when the scheme was informed of the death and when any payment is made.
- Ask the scheme to identify the precise benefit and its proposed tax treatment.
- Request its calculation of the deceased’s available lump sum and death benefit allowance.
- Do not describe a payment as tax-free merely because it is made on or after 28 October 2026.
- Check whether the death occurred before or from 6 April 2027, because the new Inheritance Tax treatment has a separate start date.
- Keep scheme correspondence and tax calculations with the estate records.
- Seek specialist tax, pensions or legal advice before distributing funds where the treatment is uncertain.
Frequently asked questions
Does the Budget announcement make all pension death benefits tax-free?
No. It removes the two-year delay as the sole reason why an otherwise tax-free benefit becomes taxable. Other Income Tax rules, the lump sum and death benefit allowance and, from 6 April 2027, the reformed Inheritance Tax treatment may still apply.
Does the change apply to a payment made before 28 October 2026?
The announced measure applies to payments made on or after 28 October 2026. Executors should not assume that it applies retrospectively to an earlier payment.
Is the change already final law?
No. Budget 2026 and the OOTLAR say that it will be introduced through Finance Bill 2026–27. The final legislation must be checked when enacted.
Does the two-year rule decide whether the pension is liable to Inheritance Tax?
No. The extension of Inheritance Tax to most unused pension funds and death benefits has a separate start date of 6 April 2027.
Official sources
This article provides general information based solely on Budget 2026 and the OOTLAR as published on 28 October 2026. The measures described require legislation and may change during the parliamentary process. This is not legal, tax, financial or pensions advice. Executors, administrators and beneficiaries should check the final legislation, contact the relevant pension scheme and obtain advice appropriate to their circumstances.