Many state pensioners will be paying back the equivalent of their entire £200 winter fuel payment in income tax by the end of the decade, should the Chancellor extend a freeze on tax thresholds at the Budget, analysis shows.
The £12,570 threshold at which people start owing income tax at a rate of 20 per cent has been frozen since 2022. If this continues, and the state pension continues to increase, retirees will start owing tax on it within the next two years.
By 2030, analysis from Quilter shows that growing tax bills will wipe out the £200 winter fuel cash boost many receive.
The Government removed universal winter fuel payments for most households last year and then reinstated them – but with means-testing – amid heavy criticism.
Currently, those born before 21 September 1959 get the winter fuel payment – worth £200 or £300 – as long as their income is below £35,000, with those earning above this having it recovered through the tax system.
But by 2030, those getting the full new state pension could end up owing around £200 tax on it, as it will grow to over £13,500 a year under the triple lock mechanism.
How is the £200 tax bill calculated?
The £200 tax bill comes from the fact that people owe 20 per cent income tax on their income over £12,570.
The full new state pension, given to those who retired in 2016 or later, will hit £241.30 per week in April, but rises annually in line with inflation, average earnings, or 2.5 per cent.
And Quilter’s calculations suggest that by the 2029/30 tax year, those getting the full state pension will receive a taxable amount of £13,570.85.
The £12,570 income tax threshold is due to start rising along with inflation from 2028 under current plans, but Chancellor Rachel Reeves is widely expected to extend the freeze to 2030 in Wednesday’s Budget.
If this happens, pensioners getting the full new state pension will pay tax on the £1,000.85 that is above the tax threshold, resulting in a tax bill of £200.17 – almost identical to the £200 many receive as their winter fuel payment.
The state pension is set to rise by 4.8 per cent in April under the triple lock, and Quilter’s calculations assume it will increase by 3 per cent in 2027 and then 2.5 per cent in 2028 and 2029.
This takes the full amount to £261.10 per week, or £13,623.83 per year in 2029/30.
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HMRC calculates tax on the state pension as 51 weeks at the new rate and one week at the previous year’s rate, because the uprating happens partway through April.
This is why by 2029/30 the taxable pension is set to rise to £13,570.85, leaving pensioners owing £200.17.
Should the lock increase by more than 2.5 per cent in the next couple of years, pensioners could be paying back their winter fuel payment even sooner.
Adam Cole, retirement specialist at Quilter, said the policy risks turning the pension system upside down.
He said: “Should the Government opt to extend the freeze on income tax thresholds, we will soon be in a perverse situation where pensioners will have to start paying back their state pension to HMRC.
“In just a few short years, those with incomes comprised of solely the state pension will not only be paying tax, but they will do so at levels that would erase the Government’s winter fuel payment, which is designed to help those who are most vulnerable.”
Cole also warned that the increase in the state pension could drag some over the threshold at which they stop receiving the winter fuel payment – £35,000 – in the next few years.
He said: “Those with other income (circa £22,000) who currently receive this today could lose entitlement because of future state pension increases.”
He warned that not uprating the £35,000 threshold would make matters worse by “resulting in many losing the benefit entirely”.
Freezing tax thresholds could be one of Reeves’s last remaining levers
The Government has pledged not to raise headline income tax rates in its election manifesto, but still needs to raise tens of billions of pounds at the Budget.
This is why many experts think Reeves will resort to a threshold freeze.
Cole noted that “extending the freeze on income tax thresholds once seemed unlikely given it was used as the Chancellor’s ‘rabbit out of the hat’ moment at her 2024 Budget, with her saying plainly that to do so would hurt working people.
“Opting to row back on this position could be damaging, but the tides have since changed and the Chancellor has been left with few other options.”
Extending the freeze may be one of the few remaining levers. Cole added: “Reeves faces a large fiscal hole and is seemingly scrabbling around trying to fill it, all while trying to save face with the public.
“However, an extended threshold freeze is no longer a stealthy move. The Chancellor said herself that such a move would hurt working people, but this time it would go further and hit some of the most vulnerable.”
The Treasury has been contacted for comment.
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