The new state pension could pay as much as £11,501 next year, if the Government applies the full triple lock increase. That is still below the £12,570 personal allowance, which marks the point at which people start paying basic rate income tax, but it’s creeping closer.
State pension payments are added to retired people’s earnings from all sources, including employment, pensions and investments, with the total subject to income tax.
This means that millions still pay income tax after hitting state pension age, although most no longer pay National Insurance.
There is nothing new about that. While some pensioners live on a shoestring, others are comfortable and the Treasury will want to tax them.
What is new is that Chancellor Jeremy Hunt has frozen the personal allowance at £12,570 all the way to April 5, 2028.
The higher rate tax threshold is frozen at £52,270, while the additional rate 45 percent tax band was slashed from £150,000 to £125,140 in April. That’s also frozen.
This is generating a tax bonanza for the Treasury by pushing millions into higher income tax brackets.
Around 8.1million pensioners are set to pay income tax this year, almost one in four. That’s a rise of 25 percent on the 6.47million who paid just three years ago, HMRC figures show.
And their numbers will grow thanks to those frozen tax thresholds.
As well as paying more income tax, pensioners with savings risk losing access to two hugely valuable tax allowances.
Jason Hollands, managing director at wealth management firm Evelyn Partners, said if the new state pension does hit £11,501 next year, millions will be banging their heads against the personal allowance.
“Just £1,069 of a pensioner’s tax exemption will be left after state pension is taken into account, down from £1,970 in the current financial year.”
Even those with small private incomes will be tipped into paying basic rate tax at 20 percent, he added. “Estimates suggest that half a million more pensioners will become taxpayers in the next tax year as a result.
If the state pension increases by just over three percent a year for the next three years that will lift it above the personal allowance, Hollands added.
“This could force HMRC to tax the state pension at source, which would be massively unpopular.”
That’s further down the line, though. Savers face a more immediate tax headache today.
Under the personal savings allowance (PSA), basic rate 20 percent taxpayers can earn £1,000 of savings interest each year before paying income tax on the money.
That falls to £500 for 40 percent taxpayers, while additional rate 45 percent taxpayers do not get a PSA.
Breaching the PSA was a rarity in the days when savings accounts paid just one percent or so, but with best buy accounts now paying up to 6.2 percent some three million risk busting through it.
So as well as paying more income on their earnings, their PSA may be cut. This will leave more of their savings interest at the mercy of HMRC.
This increases the arguments in favour of putting money into a cash ISA rather than a standard savings account, even if they do pay slightly less interest.
And here’s another incentive to save in an Isa.
Savers need to watch out for another triple lock tax “sting in the tail”, warns Jeremy Cox, head of strategy at Coventry Building Society.
Under the incredibly complicated starting rate for savings, savers whose incomes are below the £12,570 personal allowance can earn up to £5,000 of interest free of tax.
“Once combined with the £1,000 PSA, savers can earn up to £18,570 a year from income and savings interest without paying any tax on savings interest. But if a state pension increase takes them past this point, they’ll start paying tax on any savings interest above £1,000,” Cox said.
Unless the personal allowance is increased in the next year or two, Hunt’s tax trap will tighten. And it’s already hitting millions of pensioners today. Yet with careful planning and diligent use of Isas, many can cut their exposure.