Hundreds of thousands of pensioners will have to start setting aside some of their state pension for unexpected tax bills, a former UK government minister has claimed.
A combination of big increases in the state pension – with a rise of 8.5% scheduled for next spring – and a continued freeze in income tax thresholds means growing numbers of older people will be dragged into the tax net “purely on the basis of their state pension”, says the ex-pensions minister Steve Webb.
Although the state pension is paid gross (before tax is deducted), any tax owed as a result can usually be collected via your PAYE tax code for any workplace pension or earnings you may be getting.
However, for people receiving large state pensions but no other income or earnings, there is no automatic way of collecting the tax they owe.
They may not realise they will have to pay until they get a demand out of the blue from HM Revenue and Customs, by which time they may have spent all of their pension cash, says Webb, now a partner at the actuarial business LCP.
It was confirmed this week that under the triple lock, the state pension is expected to rise by 8.5% in April 2024, in line with earnings, although there is speculation that the government may hope to limit the rise to between 7.8% and 7.9%. We may find out more in the autumn statement on 22 November.
With the income tax threshold frozen at £12,570 since 2021-22, anyone with a state pension next year of more than £242 a week will have some tax to pay.
While the full basic state pension is £156.20 a week (and the maximum new state pension is £203.85 a week), a lot of older people receive “Serps pension” on top (Serps is the old top-up state pension) – perhaps as much as £200 or so a week.
According to official statistics, more than 2.3 million pensioners had a state pension of £195 a week or more in November 2020. Taking account of state pension rises since then, and assuming another chunky rise next spring, all – or almost all – of these people would have a pension over the tax threshold next year.
Some of these pensioners will have private pensions or other sources of income from which HMRC can collect the tax owed but hundreds of thousands of them won’t, LCP estimates.
This is the group now at risk of getting unexpected tax bills, it says. They may need to consider setting aside some of their state pension each month so that they have the funds available to pay a future tax demand, Webb says.
Because these new taxpayers have not previously had to fill in a tax return or had much dealings with HMRC, they may be surprised to receive a letter demanding tax, and some might even think it is a scam.
HMRC will write to pensioners after the end of the tax year, telling them they haven’t paid the tax due on their state pension and requiring them to make a payment before 31 January the following year.
“This means pensioners could have received – and spent – all of their pension during one financial year, only to receive a tax bill on that pension the following year,” LCP says.
A Treasury spokesperson told Guardian Money that pensioners whose sole income is the basic state pension or new state pension do not pay any income tax, adding: “This year we provided the biggest ever cash increase to pension payments – a 10.1% rise.”
They added that by raising personal thresholds over the past decade, “we have taken 3 million people out of paying tax altogether. The best tax cut we can provide right now is to halve inflation, which we’re on track to do this year as long as we stick to our plan.”
