A major UK pension provider has warned that state pensioners face greater complexity in managing their tax affairs and has urged them to review their household income as new rules come into effect.
Chancellor John Healey announced at the Autumn Budget that a new Pensions Tax Allowance will be introduced for certain state pensioners. The allowance will ensure that anyone of state pension age whose total income is no more than the value of the full new state pension — set to rise to £13,037 a year next April — will not pay income tax, by adding an extra allowance on top of the standard £12,570 personal allowance.
Planning ahead for the change
Kate Smith, head of pensions at Aegon, urged people to plan ahead for the changes, which come into force from April 2027. She said: "Those above state pension age will need to understand their income sources, ensure their HMRC records are up to date and check whether they will benefit from the new Pension Tax Allowance."
She added: "This may be a challenge for vulnerable pensioners, but it is important to ensure HMRC applies the correct tax reduction." People do not need to be receiving the state pension for the allowance to apply.
How the allowance works
Ms Smith explained: "The Pension Tax Allowance is based on your total income, regardless of the source. This includes income from the state pension, other pensions, work, savings, dividends and property."
Once income rises above £13,037, the allowance will taper off, reducing by £1 for each £3 earned until income reaches £13,319 a year. Above this level, no Pension Tax Allowance is given, and the standard £12,570 personal allowance applies instead. The policy was introduced to protect people whose only income is the full new state pension from paying income tax, as the full new state pension will move above the £12,570 personal allowance next April.
Relief and complexity
Ms Smith said the new provision will provide relief for state pensioners, although it makes the system more complicated. She said: "Affected pensioners above the state pension age will welcome the new Pensions Tax Allowance. Those whose total income is no more than the value of the new state pension (£13,037) will no longer face the administrative hassle of paying income tax. The taper between £13,037 and £13,319 per year will also be a relief to those with slightly higher incomes, including from work or pensions, and helps to remove the cliff edge."
She warned that the change does make life more complicated: "It introduces a level of complexity for a relatively small uplift. It may be difficult for those affected, especially vulnerable pensioners, to understand, and for the Government to deliver by next April."
A simpler alternative
Ms Smith suggested a more straightforward solution the Government could have chosen. She said: "A simpler way to ensure that those living on the state pension alone do not pay income tax would have been to increase the personal allowance to align with the state pension, ideally for everyone to avoid intergenerational unfairness."
She added: "This would be simpler but comes at significant cost. In theory, the new Pension Tax Allowance ends in 2030, when the Government will need to look at alternative solutions, which should include increasing the personal allowance for all."
