An estimated 12 million people could face having to pay income tax on their state pension from 2027, experts have warned.
The state pension is currently set at £11,502.40 – just £1,067.60 below the personal allowance threshold of £12,570.
However, a 4.1% increase to the state pension next week will see it rise to £12,014, bringing it, in the words of Royal London’s Clare Moffat, “perilously close” to exceeding it.
With inflation expected to be 3.2% over the next year, according to predictions by the OBR, it would rise to £12,398.57 in 2026/27.
And Aegon’s pensions director Steven Cameron estimates that by the 2027/28 tax year, the state pension will increase to £12,579.13, or £9.13 above the threshold.
The personal allowance threshold is currently frozen until 2028 – but there are rumours that chancellor Rachel Reeves may look to extend it until 2030.
Recent research from Royal London found that 21 million people aged 21-65 are unaware that the state pension is taxable.
As a result, Moffatt said, it could come as a shock to many.
Cameron agreed. Speaking to Money Marketing, he said he was worried pensioners might be concerned to “suddenly receive an unexpected tax bill from the tax man through the door”.
“The first year it may only be £1.83 or so, but receiving that letter from HMRC may send some into a bit of a panic,” he added.
“It’s something that we and others have flagged as a risk in the past.
“With inflation not having come down to the Bank of England’s target, there’s a higher risk now the state pension will exceed the income tax threshold quicker than we might have been thinking a year ago.
“Even if the state pension goes up by the minimum, you get up to 2027/28, we got up to £12,579 and at that point you’re above. You’re only £9 above, but you’re above.
“So, in theory, state pensioners with no other income would be liable to pay income tax on £9.13 a year.”
Cameron questioned whether the cost of doing the calculations, contacting the individual, asking them to make the payment and collecting it would wipe out any actual revenue that HMRC received.
“I think that HMRC probably wouldn’t come after people when there’s such a small tax amount due,” he said.
“But if they don’t make that clear, the worry is that you’ve got all these state pensioners who’ve got nothing other than the state pension, who are pretty much on the breadline, and they’re getting worried they might end up getting a tax bill through the letterbox.
“It might only be £1.83, but they’ll just think, ‘Oh my God, I’ve not paid my tax, what if the tax man comes after me?’
“I think it could create a lot of concern and anxiety among some state pensioners, probably for no good reason.
“I’m not bad mouthing the media here, but that’s the sort of thing that you can imagine some of the consumer press making a thing of. ‘Oh, you might have to pay income tax on your state pensions.’ It would create a fear, and that’s something that I really want to see avoided.”
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Cameron says that if the plan is to unfreeze the personal allowance at some point in future, “then I think that for that two-year interim period HMRC should come out and confirm that they will not pursue any state pension for such a small amount of tax”.
“And to tidy things up, if the state pension was a few pounds over the personal allowance threshold when it becomes unfrozen, then I might argue that why doesn’t the government just round up the personal allowance?”
However, Cameron said, “what if Rachel Reeves decides that the nation’s finances are so bad she’s going to freeze the personal allowance for another couple of years?”
“If that were to happen, and the state pension goes up by at least 2.5%, by 2028/29 that gap begins to become more meaningful at £323.61 over.
“And by 2029/30, it could be that someone who’s on the state pension, and nothing else, could be £645.95 above the personal allowance threshold.
“This would mean they would be liable to pay around £130 tax that year.”
This potential for the state pension to be taxed once again brings into question how sustainable the triple lock is in the long-term.
First introduced by the coalition government, it came into effect 2011/12 and has been applied every year since, except for a temporary suspension in 2022/23.
The triple lock is a commitment to increase state pensions by whichever is highest of average earnings growth, CPI inflation, or 2.5%.
During the Conservatives election campaign, then prime minister Rishi Sunak pledged to introduce a ‘triple lock-plus’ model to solve the issue.
This, he argued, would mean the state pension would never exceed the personal allowance for the duration of his time in office.
When asked what he thought, Cameron said: “I do think that the triple lock can’t survive indefinitely.
“If it does, then state pensioners will, over time, receive above national average earnings increases.
“So effectively, state pensioners will be getting bigger increases than the working age population and I don’t think that’s sustainable long-term.
“I think we need a pragmatic solution. This needs to be tackled; it can’t just be left. It’s not going to go away.
“Someone at some point is going to have to do something about it.”
Standard Life retirement savings director Mike Ambery said: “A decision on how to approach the state pension’s relationship with the personal allowance will surely need to be made before 2028, the year in which the tax allowance and brand freeze is set to be lifted.
“There are a few options on the table – the chancellor could lay out a plan to lift the personal allowance freeze for everyone, which would generate consistency between workers and pensioners but come at a fiscal cost.
“She could also consider bringing in a mechanism by which the personal allowance increases for pensioners alone, similar to the Conservative government’s ‘triple lock plus’ plan – less costly but risking a charge of generational bias.
“Or she could reassess the triple lock itself – unlikely given recent commitments to the policy, including recently from the pensions minister.
“The reality is any inflation-busting state pension increase next year is likely to raise questions both on taxation and the long-term affordability of the policy.”
