Frozen thresholds will see hundreds and thousands of retirees paying tax on their state pensions for the first time next year.
The state pension is set to increase by 4.1 per cent for the 2025/26 financial year, pushing more pensioners over the £12,570 personal tax allowance threshold.
This rise, based on the triple lock guarantee, will see the full new state Pension climb from £221.20 to £230.30 per week.
However, the frozen tax threshold until 2028 is expected to result in nearly 900,000 more people paying tax on their pension income this year alone.
Alice Haine, Personal Finance Analyst at Bestinvest, said that pensioners are “edging closer to the point at which their state pension income becomes liable for tax”.
The increase, while welcome for many retirees, is set to have significant tax implications for a growing number of older Britons.
Nearly 900,000 more people will exceed the Personal Allowance threshold of £12,570 over the current financial year, according to retirement experts at Spencer Churchill. This trend is set to continue, with potentially 2 million pensioners affected by 2028.
The situation is particularly challenging for those relying primarily on the state pension. As the pension amount increases, the gap between annual payments and the personal allowance narrows significantly.
For instance, next year’s full new state pension will rise to £11,975.60 annually, leaving just £595 before the tax threshold is reached. This equates to only £50 per month in additional income before pensioners may face tax liability, a stark contrast to the current £89 monthly buffer.
Similarly, basic state pension recipients will see payments increase to £9,175.40 annually. This leaves £3,395 before the personal allowance is exceeded.
Adam Pope, retirement expert at Spencer Churchill Claims Advice warned of the financial impact. He said: “Freezing income tax thresholds for pensioners is worrying and could really affect their financial situation. Almost two million pensioners are expected to be hit by this in the next four years, meaning many of them will have to pay more tax.”
“This is especially tough for those mainly living off the state pension. With no change in the tax thresholds, they could find themselves owing more tax than they expected, making things hard if they don’t have much to begin with.”
The average tax-paying pensioner could be £1,000 worse off by 2027/28, potentially impacting living standards and financial security.
Former Pensions Minister Steve Webb, now partner at LCP estimated that even a modest pension rise could draw over 300,000 more pensioners into the tax net. He explained that around two-thirds of all pensioners now pay income tax, typically at the basic rate.
The issue is compounded by the rising state pension and frozen thresholds. In 2022/23, nearly 700,000 people received tax demand letters from HMRC, with an average request of £665 each.
Chancellor Rachel Reeves is expected to confirm the new state pension and benefits rates during the Autumn Budget on October 30.
The rising state pension and frozen tax thresholds are creating a complex financial landscape for retirees. Helen Morrissey, head of retirement analysis at Hargreaves Lansdown said: “State pension forms the foundation of our retirement income and people need certainty as to what they are going to get and when.”
She suggested that the upcoming review is an opportunity to assess the state pension and the triple lock’s role within it.
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The situation is particularly challenging for those with additional income sources.
Haine added that retirees already receiving a higher state pension may already be paying tax on the benefit, while those with private pension income will see more of that income taxed.
As the state pension continues to rise, the frozen personal allowance creates a growing tax burden for many pensioners, potentially affecting their financial planning and retirement security.
