Key Takeaways:
- The UK government is expected to extend the freeze on tax thresholds, which could lead to pensioners paying more tax on their state pension.
- This could result in pensioners losing their £200 winter fuel payment, which is designed to help vulnerable individuals.
- The state pension is set to rise by 4.8% in April, but the tax threshold freeze could mean that pensioners pay tax on their increased pension income.
- Experts warn that this policy could turn the pension system upside down and hurt vulnerable individuals.
- The government is facing a large fiscal hole and is looking for ways to raise £20-30 billion, with extending the tax threshold freeze being one of the few remaining options.
Introduction to the Tax Threshold Freeze
The UK government is expected to extend the freeze on tax thresholds in the upcoming Budget, which could have significant implications for pensioners. The freeze, which has been in place since 2022, means that the tax thresholds do not rise with inflation, resulting in more people paying more tax as their wages grow. This policy is expected to raise £7.5 billion for the Chancellor, but it could also lead to many state pensioners starting to pay tax for the first time from April 2027.
The Impact on Pensioners
The £12,570 income threshold at which people start paying income tax has been frozen since 2022, and if this continues, retirees will start paying some income tax on their state pension alone 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. This is because the full new state pension will hit £241.30 per week in April, and will rise annually in line with inflation, average earnings, or 2.5% under the triple lock mechanism. As a result, those getting the full 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.
How the £200 Tax Bill is Calculated
The £200 tax bill is calculated based on the fact that people pay 20% income tax on their income over £12,570. The full new state pension will rise to £13,570.85 by the 2029/30 tax year, resulting in a tax bill of £200.17. This is because the state pension is set to rise by 4.8% in April, and will continue to increase by 3% in 2027 and 2.5% in 2028 and 2029. 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.
The Risk of Turning the Pension System Upside Down
Experts warn that the policy of extending the tax threshold freeze could turn the pension system upside down. Adam Cole, retirement specialist at Quilter, said that the policy risked creating a perverse situation where pensioners will have to start paying back their state pension to HMRC. He added that the increase in the state pension could drag some over the threshold at which they stop receiving the winter fuel payment, resulting in many losing the benefit entirely. Cole also warned that not uprating the £35,000 threshold would make matters worse, resulting in many losing the benefit entirely.
The Government’s Limited Options
The government has pledged not to raise headline income tax rates in its election manifesto, but still needs to raise an estimated £20-30 billion at the Budget. This is why many experts think the Chancellor will resort to extending the tax threshold freeze. Cole noted that extending the freeze on income tax thresholds once seemed unlikely, given that 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. However, the tides have since changed, and the Chancellor has been left with few other options.
The Need for a Minimum Income Guarantee
Campaigning Labour MP Rachael Maskell said that two million people of pension age live in poverty, having to make a choice between heating and eating. She added that it is crucial that any change at the budget does not place more older people into hardship, and that a Minimum Income Guarantee for older people would help protect the most vulnerable people in later life. The Treasury has been contacted for comment, but it remains to be seen how the government will address the issue of pensioners paying more tax on their state pension.