The interaction between the rising state pension and the frozen personal tax allowance is creating a situation where more pensioners could find themselves paying income tax. Here's a breakdown of the key points:
State Pension as Taxable Income:The state pension is considered taxable income, although it's paid without tax being deducted at source. If a pensioner's total income exceeds the personal tax allowance, they become liable for income tax.
The Personal Allowance:The personal tax allowance is the amount of income a person can earn before paying income tax. This allowance has been frozen.
Rising State Pension: The state pension, on the other hand, has been increasing, particularly due to the "triple lock" policy. This means it rises in line with the highest of earnings growth, inflation, or 2.5%.
The Consequence:As the state pension rises and the personal allowance remains frozen, more pensioners are likely to see their income exceed the tax threshold.This situation could lead to more pensioners having to pay income tax on their state pension.
How Tax is Collected:Usually, if a pensioner has other sources of income, such as a private pension, the tax owed on the state pension is collected through that source.However, if the state pension is the pensioner's primary income, they may have to pay the tax directly to HMRC, potentially through a self-assessment.The combination of a rising state pension and a frozen personal allowance is increasing the likelihood of pensioners facing income tax obligations.
Pensioners may be required to pay income tax on their state pensions for the first time as early as next year, according to new study, if payments surpass the personal tax allowance by April 2026.
Analysts are warning that this "stealth tax" on seniors will compound the continuing cost of living issue for elderly people. According to Deutsche Bank predictions, annual state pension benefits might increase by 5.5% to £12,631 in April 2026. This would increase pension payouts beyond the £12,570 tax-free personal allowance.
The personal allowance has been frozen since 2021 and will remain so until April 2028. Low-earning state pensioners would consequently be forced to hand money back to the state through income tax.
Official Office for Budget Responsibility (OBR) forecasts released with the Budget had suggested pension payments wouldn't breach the personal allowance until April 2027.The acceleration creates a stealth tax raid on pensioners. Tax thresholds have been frozen since 2021/22 which has resulted in fiscal drag.Fiscal drag occurs when tax allowances are frozen over a period of high inflation or wage rises, resulting in Britons being pulled into higher brackets.
Thanks to the triple lock, state pension payments are guaranteed to rise every year by either the rate of inflation, average wages or 2.5 per cent; whichever is highest.This means more of any pension increase will be taken by the government through taxation. Sarah Coles, head of personal finance at Hargreaves Lansdown, described the situation as a "stealthy squeeze on our wallets".
"The freeze has already hit taxpayers hard. In 2024/25 there are an estimated 37.4 million income taxpayers, up 4.4 million from when thresholds were frozen in 2021/22," she said.
There are now 8.5 million taxpayers over state pension age - around a quarter more than before thresholds were frozen.
Deutsche Bank's analysis reveals average weekly earnings in the three months to July will be 5.5 per cent, which is higher than both projected inflation and the 2.5 per cent minimum.
As long at the triple lock mechanism remains in place, pension payments are likely to rise by this amount next year.
Rob Morgan, analyst at wealth manager Charles Stanley, criticised the situation.
"Something's got to give. The state pension is a safety net so this seems wholly inappropriate,he added.
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