Older workers who put off claiming their state pension could face tax bills of up to £560 that those who take their pension immediately will avoid, under a loophole in Labour's planned tax protection for pensioners. The policy could effectively penalise people who choose to continue working and defer their state pension, according to former pensions minister Sir Steve Webb.
Tax protection gap for deferrers
Former chancellor Rachel Reeves said last year that pensioners whose only income is the state pension would not have to pay income tax. But the protection does not apply in the same way to people who delay taking their pension and receive a higher weekly payment as a result.
Sir Steve, now a consultant at LCP, warned that the rules could leave older workers facing a "tax penalty" worth "hundreds of pounds".
Pension set to exceed tax threshold
The issue is set to become increasingly important from April 2027, when the full new state pension is expected to exceed the £12,570 personal allowance for the first time. The full new state pension currently stands at £12,547 a year - just £23 below the tax-free threshold.
Labour has confirmed that the £12,570 personal allowance will remain frozen until 2031, while the triple lock will continue to push up the value of the state pension. As a result, the full pension is expected to move above the tax threshold from April next year.
Analysts expect the next increase to be driven by wage growth, potentially taking the annual full new state pension above £13,000. Normally, someone receiving that amount with no other taxable income could face an income tax bill of around £100 a year. Under Ms Reeves's exemption, however, pensioners whose sole income is the standard state pension would be protected from paying it.
Cost of deferring for a year
Those who deferred their pension could find themselves in a very different position. Someone who postponed claiming for 12 months before beginning to receive their state pension from April 2027 could face an annual tax bill of as much as £560, while someone who claimed immediately could pay no income tax at all.
Sir Steve said this risked undermining the Government's wider aim of encouraging older people to remain in the workforce. "Deferral can be attractive for some people. If you want to work on, you don't really want to add your state pension to your wages and pay lots of tax," he said. "But now it turns out there can be a tax disadvantage and, over the next three years, that will cost you hundreds of pounds."
He added: "It seems odd to penalise those who defer and not those who don't. On the whole, the Government wants people to work longer and this is a tax penalty for those who work longer who work and defer taking their pension."
Deferring the state pension increases the eventual payment by one per cent for every nine weeks it is delayed - equivalent to just under 5.8 per cent over a year.
Royal London figures show that almost 42,000 people claimed a deferred state pension in 2023-24, while one in four of those who deferred had postponed claiming for five years or more.
The exemption itself is also expected to benefit only a relatively small proportion of Britain's pensioners. Analysis by LCP published earlier this year found that it would protect around 800,000 of the UK's 13.2 million state pensioners - roughly one in 17.
Pensioners who receive additional state pension income would not qualify. The analysis found that around 7.7 million people on the basic state pension would also be excluded, alongside 1.6 million people living overseas or earning below the taxable threshold. A further two million would miss out because they have other sources of taxable income.
A Treasury spokesman defended the policy, saying: "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."
