Liposomal drug dry powder formulations have shown many promising features for pulmonary drug administration, such as selective localization of drug within the lung, controlled drug release, reduced local and systemic toxicities, propellant-free nature, patient compliance, high dose carrying capacity, stability and patent protection. Critical review of the recent developments will provide a balanced view on benefits of liposomal encapsulation while developing dry powder formulations and will help researchers to update themselves and focus their research in more relevant areas. In liposomal dry powder formulations (LDPF), drug encapsulated liposomes are homogenized, dispersed into the carrier and converted into dry powder form by using freeze drying, spray drying and spray freeze drying. Alternatively, LDPF can also be formulated by supercritical fluid technologies. On inhalation with a suitable inhalation device, drug encapsulated liposomes get rehydrated in the lung and release the drug over a period of time. The prepared LDPF are evaluated in vitro and in vivo for lung deposition behavior and drug disposition in the lung using a suitable inhaler device. The most commonly used liposomes are composed of lung surfactants and synthetic lipids. Delivery of anticancer agents for lung cancer, corticosteroids for asthma, immunosuppressants for avoiding lung transplantation rejection, antifungal drugs for lung fungal infections, antibiotics for local pulmonary infections and cystic fibrosis and opioid analgesics for pain management using liposome technology are a few examples. Many liposomal formulations have reached the stage of clinical trials for the treatment of pulmonary distress, cystic fibrosis, lung fungal infection and lung cancer. These formulations have given very promising results in both in vitro and in vivo studies. However, modifications to new therapies for respiratory diseases and systemic delivery will provide new challenges in conducting well-designed inhalation toxicology studies to support these products, especially for chronic diseases.