HMRC has clarified how the state pension tax code change works, confirming that the state pension is taxable but the Department for Work and Pensions (DWP) does not deduct tax at source. This means HMRC adjusts tax codes to recover any tax owed later.
In a message to a state pensioner on X, HMRC's Customer Support account explained: "The State Pension is taxable, but the DWP doesn't take tax at source, so we change your tax code to give enough of your tax free allowance to match the State Pension, leaving whatever's left for a private pension."
Triple lock set to push pensions above tax-free threshold
Next year, the triple lock is set to increase state pension payments for new state pensioners to above £12,570, meaning those with only the new state pension income would owe tax. This has led to confusion, with many believing the state pension is tax-free because they have not previously paid tax on it.
However, the state pension has always been liable to tax. The situation is set to become more complex as former Chancellor Rachel Reeves announced that state pensioners with no other income will be given a special exemption from tax on their DWP payments. New Prime Minister Andy Burnham and Chancellor John Healey have confirmed they will commit to this policy, though details are yet to be published.
Exemption details remain unclear
The government has not confirmed how the exemption will work in practice, except that older basic state pensioners receiving Additional Pension payments will not be exempted.
Rachel Vahey, head of public policy at AJ Bell, said: "Under the triple lock guarantee, the state pension rises annually by the highest of average earnings growth in May to July, September’s inflation figure or 2.5%. With earnings growth coming in at 4.8%, the state pension will increase to around £12,548 – putting it above £12,000 for the first time and within inches of the frozen personal allowance."
She added: "Low income pensioners have been promised that, from April 2027 when the full state pension is projected to exceed the tax-free personal allowance, nobody will pay tax if their only income came from the state pension. That measure is designed to avoid the unwelcome optics of government giving pensioners a benefit on one day, only to then ask for some of it back the next."
Vahey noted: "It is still unclear exactly how the policy will be implemented and it’s hard to see how such a measure can last long-term. State pension incomes will continue to grow faster than the frozen personal allowance until at least 2031, by which time the tax break could be worth hundreds. But it will only apply to those with the state pension as their sole source of income and there are no plans to extend it to low income pensioners with private pension income. It means two pensioners on identical incomes could find only the one with private savings has to pay any tax."
