George Osborne is set to abolish the 55% tax duty paid on the undrawn pensions of the deceased from next April.
Speaking at the Tory conference today, the chancellor said he would axe what he called the 'death tax' that is levied when those aged 75 or over pass on untouched defined contributions on a pension pot to dependents, and to pensions already in a drawdown account.
Beneficiaries will now only pay the marginal income tax rate, or no tax at all if the individual dies before they reach 75, if it is in a drawdown account or uncrystallised.
The Treasury predicts that this policy is expected to cost around £150m per year.
In a Tweet, Osborne said: 'Next stage in pension reforms is abolishing death tax on pensions so people who've worked hard and saved can pass their pension on tax free.'
The idea was proposed in July, when the Treasury launched its Freedom and choice in pensions consultation.
Tom McPhail, head of pensions research at Hargreaves Lansdown, said the changes to the tax rules would be a 'mixed blessing'.
He said: 'They will encourage investors to take the maximum possible advantage of their pension contribution allowances, which is certainly a good thing. Investors can build up their pension fund, secure in the knowledge that they can not only draw on their savings without restriction from age 55 but in addition, any unused savings can be passed on to their inheritors tax free on death.
'It is therefore likely to significantly boost demand for income drawdown in retirement and to diminish the relative attraction of annuities. It will also encourage investors to preserve their pension funds to meet the cost of care funding.'
Yvonne Braun, assistant director and head of savings, retirement & social care at the Association of British Insurers, said the tax change was 'a sensible move which deserves support'.
'A 55% tax charge if someone dies before they have accessed their pension fund goes against the grain of the wider government policy of making pension saving more popular by giving people more options on how to use their retirement savings,' she said.
Actuaries Barnett Waddingham said the proposed abolition of the 'hefty' 55% tax charge was 'extremely good news' and would 'surely be welcomed'.
Malcolm McLean, a senior consultant said at the firm, said: 'In an ideal world all tax charges on pension funds inherited on death would be abolished without a distinction between those aged under and over 75, or at least would only apply where the death occurred at a later age than 75.
'Under the circumstances, however, the chancellor has probably gone further than many in the pensions industry expected and is to be commended for making the changes he has now announced.'