Policy paper

Tax treatment of pension and lump sum death benefits under the two-year rule

Published 28 October 2026

Who is likely to be affected 

Scheme administrators of registered pension schemes, scheme managers of pension schemes outside the UK and beneficiaries of members of registered pension schemes. 

General description of the measure 

The requirement that scheme administrators must pay tax-free death benefits to beneficiaries within two years of learning of the death of a member aged under 75 (the ‘two-year rule’) is being removed.

Under the change a lump sum death benefit paid to a beneficiary more than two years after the scheme became aware of the member’s death will no longer be subject to a tax charge, provided the member had sufficient lump sum and death benefit allowance available.

The two-year limit is also being removed where beneficiary annuities are paid from the deceased member’s drawdown funds and where funds are designated for a UK resident under a pension scheme outside the UK. 

Policy objective 

This measure makes the tax system fairer and administratively less burdensome by removing the two-year time limit scheme administrators have to pay tax-free death benefits for beneficiaries. 

Background to the measure 

Since April 2015 most lump sum death benefits are not taxed if the member died before reaching age 75 and had either sufficient remaining lifetime allowance or, since 2024, sufficient remaining lump sum and death benefit allowance. However, these lump sum death benefits will be taxable if the scheme administrator pays them more than two years after they learned of the member’s death. This two-year rule applies even where neither the scheme administrator nor the beneficiaries have control over the delay.  

The government has confirmed that from Budget Day 2026, lump sum death benefits payable in respect of a member who died before reaching age 75 will be payable tax-free even if the scheme administrator had known of the member’s death for more than two years.  

Detailed proposal

Operative date 

The measure will have effect in relation to payments made on or after Budget Day 2026. 

Current law  

Registered pension schemes are tax-advantaged vehicles intended to encourage saving for retirement. The legislation is mainly set out in Part 4 of Finance Act (FA) 2004 and supporting regulations. 

Current law relating to lump sum death benefits paid out of registered pension schemes is contained in Part 2 of Schedule 29 to FA 2004. Where the beneficiary is an individual then the tax treatment relating to the two-year rule is set out in sections 637H to 637M of the Income Tax (Earnings and Pensions) Act (ITEPA) 2003. Lump sum death benefits are taxed as pension income and tax is deducted under PAYE. Where the beneficiary is not an individual, such as a trust or the estate of the member who died, then the tax treatment relating to the two-year rule is set out in section 206 FA 2004. In these circumstances the lump sum death benefit is subject to the special lump sum death benefits charge at a flat rate of 45%. 

Sections 646B and 646C ITEPA 2003 set out the two-year rule for beneficiary annuities paid from the drawdown funds of a deceased member who had not reached age 75 and section 573 ITEPA 2003 sets out the rule for funds designated into the equivalent of drawdown for a UK resident under a pension scheme outside the UK. 

Proposed revisions 

Legislation will be introduced in Finance Bill 2026-27 to amend FA 2004 and ITEPA 2003. 

Changes will remove the requirement for scheme administrators to act within two years of becoming aware of the death of a member who died before reaching age 75. As a result, lump sum death benefits and beneficiary annuities paid from the deceased member’s drawdown funds will remain tax free after the two-year period. This will apply whether the payment is to an individual or to a non-qualifying person such as a trust or a deceased member’s estate. The change will also apply where funds under the deceased member’s pension scheme outside the UK are designated into the equivalent of drawdown for a UK resident beneficiary.  

Therefore, where the member died before reaching age 75, the scheme administrator will no longer have to deduct and pay tax to HMRC solely because a payment was not made within two years of them becoming aware of the member’s death. A UK resident beneficiary will also no longer have to pay tax to HMRC in relation to a pension paid from unassessed funds under the deceased member’s foreign pension scheme designated more than two years after the scheme manager became aware of the member’s death. 

Summary of impacts 

Exchequer impact (£million) 

2026 to 2027	2027 to 2028	2028 to 2029	2029 to 2030	2030 to 2031	2031 to 2032
-5	-15	-15	-15	-15	-15

These figures are set out in Table 6.1 of Budget 2026. More details can be found in the policy costings document published alongside Budget 2026.

Economic impact 

This measure is not expected to have any significant macroeconomic impacts. 

Impact on individuals, households and families 

This measure will impact individuals who are beneficiaries of lump sum death benefits, by removing the two-year time limit for the lump sum death benefit to be payable tax-free. This will reduce the administrative burden on individuals, families and households when there are delays in administering the pension scheme after a scheme member dies.  

This measure is expected overall to reduce the number of individuals who need to contact HMRC to claim a refund of overpaid tax.

The measure is expected to support bereaved families by removing a risk of unfair tax outcomes following bereavement, and by removing a source of time pressure during probate or other administration relating to the death of a family member. 

Equalities impacts 

This measure may apply to individuals regardless of their protected characteristics. HMRC does not hold data that it can use to assess whether there are any disproportionate impacts to protected groups. 

Administrative impact on business including civil society organisations 

The measure is expected to have a negligible impact on an estimated 4% of pension schemes that pay lump sum death benefits, by removing the two-year time limit for the lump sum death benefit to be payable tax-free. It will not affect the level of payments, as these benefits must still be paid out. 

One-off costs will include familiarisation with the change, training staff and updating guidance on lump sum death benefits. There are expected to be no ongoing costs. Ongoing savings are expected to come from scheme administrators no longer needing to monitor the two-year deadline or to deduct tax and pay it to HMRC. 

This measure is expected overall to have no impact on businesses’ experience of dealing with HMRC as it does not change any tax administration processes or obligations. There is expected to be no impact on civil society organisations.  

Operational impact (£million) (HMRC or other) 

This measure will not require any changes to IT systems or impact staff resource and therefore carries no operational cost to HMRC. 

Other impacts 

Other impacts have been considered and none have been identified. 

Monitoring and evaluation 

Not applicable, none of the evaluation thresholds apply to this measure. We will consider monitoring and evaluation in the future as appropriate. 

Further advice 

If you have any questions about this change, contact the Pensions Policy team by email policypensions@hmrc.gov.uk.