Millions of pensioners are being dragged into paying income tax as the state pension rises whilst tax thresholds remain frozen.
Latest HMRC figures reveal there were 7.13 million taxpayers of pension age for the 2022-23 tax year, marking a 5.7 per cent increase from the previous year.
This number is likely even higher now since state pensions keep rising while the personal allowance remains stuck at £12,570. The effect of the Government’s fiscal drag policy is clear, with 1.5 million more people paying tax compared to last year.
The state pension is on track to exceed the personal tax allowance by 2027, according to Office for Budget Responsibility forecasts.
This puts pensioners in what Ian Cook of Quilter Cheviot calls a “perverse situation” where they must “pay back their state pension to HMRC due to frozen allowances”.
The full new state pension is projected to reach £12,592 a year (£242 a week) in April 2027, breaching the £12,570 tax-free personal allowance.
This will create a “retirement tax” for millions of retirees who will be forced to pay income tax on their state pension. By 2029, the state pension is forecast to rise further to £13,230 annually.
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Rachel Reeves decided to keep the personal allowance frozen at £12,570 until 2028 in the October Budget. This means the rising state pension will push more retirees into taxation.
Thanks to the triple lock, state pensions increase yearly by the highest of 2.5 per cent, wage growth, or inflation. In 2022-23, the full new state pension used three-quarters of the personal allowance at £9,627.80 annually.
By 2025-26, it’s set to hit £11,973 per year, covering 95 per cent of the allowance—leaving pensioners with little to no tax-free income.
Shaun Moore, tax and financial planning expert at Quilter, warns that pensioners are “often among the worst hit by frozen tax allowances”.
He said: “Pensioners typically will be getting their income from a number of different investments and therefore lean heavily on CGT and dividend allowances to help create a retirement income in addition to their pension.”
Moore notes that if current trends continue, “by the 2027 to 2028 tax year the state pension will surpass the £12,570 personal allowance and will see all pensioners in receipt of the full new state pension forced to hand some of it back”.
The Government has made it “very difficult to avert being taxed very heavily” on retirement investments.
The current state pension stands at £221.20 per week (£11,502.40 annually) and will rise by 4.1 per cent in April, adding £472 and bringing the total to £11,974.
By April 2026, a 2.6 per cent increase will push it to £12,285 annually, and by 2027, a 2.5 per cent rise will take it to £12,592—exceeding the personal allowance.
Further 2.5 per cent increases will see the pension hit £12,907 in 2028 and £13,230 in 2029, marking a 15 per cent total rise over the next five years.
Alice Haine, personal finance analyst at Bestinvest by Evelyn Partners, describes the situation as “worrying” and “unfair”.
She said: “Landing retirees with no other sources of income with tax demands will be unfair and extremely worrying for pensioners who are already struggling to get by after the cost-of-living crisis.”
This will put “pressure on the government to unfreeze the personal allowance to prevent retirees being taxed on this vital benefit.”
Experts advise that seeking professional financial advice can help pensioners make the most of their finances.
