Thousands of pensioners who delayed claiming their state pension are expected to be among those shut out of a new income tax waiver.
The state pension is set to rise above the personal allowance next April, rising more than £500, which would push millions into paying income tax for the first time.
The Government has said people whose only income is the full state pension will not pay tax – but those who have built up extra payments by delaying their claim may not qualify for this exemption.
The warning comes as almost 42,000 people who had deferred their state pension went on to claim it in 2023-24, according to the latest figures obtained by Royal London.
The state pension rises by 5.8 per cent for every year it is deferred.
Under current plans, the £12,570 personal allowance is frozen until 2030-31 but is expected to rise to over £13,000 a year, likely to be pushed up by wage growth under the triple lock policy.
Although many state pensioners are expected to be protected from paying, Sir Steve Webb said the wording of the new waiver could leave pensioners who did the “right” thing by deferring their pension facing a higher tax bill, including workers who decided to stay in employment to boost their retirement savings.
The former pensions minister and partner at LCP warned this could potentially undermine one of the main incentives for putting off a state pension claim and cost people who want to keep working “hundreds of pounds”.
Webb told The i Paper: “When people put off taking their state pension, their reward is a higher state pension for the rest of their life. But it now seems that there is a sting in the tail.
“Those who are wholly dependent on the new state pension but get extra for having deferred taking it, could now be disqualified from the ‘tax waiver’ for some pensioners announced in the last Budget.”
He added that the presence of increments on top of the standard rate of the new state pension could mean that this cohort have to pay tax in full, whereas someone who had not deferred might be exempt from income tax in the next three years.
“The difference could amount to hundreds of pounds and may put some people off deferring in the first place.”
According to Sir Steve Webb, people who wouldn’t qualify would include:
People on the old basic pension who have any additional state pension (Serps/state second pension/graduated retirement benefit) People on the new state pension who receive a protected payment over and above the flat rate (a form of transitional protection when the new system came in) Anyone with any other taxable income – even £1 per week of income from a company or private pension would seem to count Anyone with increments to reward them for deferring their state pensionIt is not yet known precisely how the Government will protect people who receive just a state pension from paying the tax with Labour yet to explain exactly what counts as income with a study by LCP earlier this year showing just one in 18 pensioners would actually benefit.
Sarah Coles, head of personal finance at AJ Bell, said the policy was originally intended to avoid the administrative burden of collecting small amounts of tax from millions of pensioners once the state pension rises above the personal allowance but that “under the new Burnham administration this policy remains mired in uncertainty”.
Under the triple lock, the state pension rises by the highest of 2.5 per cent, inflation or wage growth.
It is expected to rise by wage growth after the latest figures showed it rose by 4.1 per cent which would mean a rise of around £500 annually in April next year, taking it over the current personal allowance – how much people can earn before paying tax – of £12,570.
Craig Rickman, personal finance expert at interactive investor, said: “While anything that aims to support retirees on low incomes should be welcomed, this policy risks fiendish complexity and instances of unfairness – potentially excluding and penalising people who are no better off than those who stand to benefit.
“Further information precisely laying out the mechanics of this policy and who will apply to is desperately needed.
“If people relying solely on the state pension will face income tax in the future by deferring it, they need to know as soon as possible.”
Rickman said the simplest way to prevent the state pension becoming taxable would be to increase the personal allowance from April 2027, rather than allowing the tax-free threshold to remain frozen while pension payments rise.
However, raising the allowance could cost the Treasury several billion pounds a year, leaving the government with difficult choices over how to make up the shortfall.
A Treasury spokesperson said: “Pensioners whose only income is the full new or basic state pension without any increments will not pay income tax and we are committed to that over this Parliament.
“By keeping the triple lock, 12 million pensioners will see their income rise by up to £470 this year, and they continue to benefit from one of the most generous personal allowances in the G7 [group of nations].”
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