State pensioners can increase their tax-free Personal Allowance to £21,330 by using two little-known but fully legal HMRC rules at the same time, provided they meet the eligibility requirements.
The income tax Personal Allowance currently stands at £12,570 and could remain frozen at that level until at least 2031. At the same time, earnings and the state pension continue to rise due to inflation and the triple lock.
State pension and the tax threshold
The state pension has always been taxable, but those who earn less than £12,570 never had to worry about it, as income tax is not paid on earnings below this Personal Allowance threshold. With the state pension now just £22 away from that threshold this tax year, many pensioners who have other income, such as savings interest, or who are still working, could exceed it and become liable for tax.
At the most recent Budget in November, Chancellor Rachel Reeves confirmed that state pensioners who receive no other income apart from the state pension will be exempt from paying income tax if they exceed the threshold, a situation expected to arise in April 2027 after another triple lock increase. This has since been backed by new Chancellor John Healey, but he and Prime Minister Andy Burnham have stopped short of promising to increase the threshold before 2031.
Marriage Allowance
The first rule is Marriage Allowance, a legal tax reduction vehicle offered by HM Revenue and Customs. Married couples and civil partners can transfer some tax allowance between one another to avoid some tax. One of the couple needs to be a non-taxpayer, earning under the £12,570 allowance, while the other must be a 20% taxpayer earning above it. This is a fairly common situation for pensioners, where one person has retired but the other is still working.
The non-taxpayer pensioner applies to HMRC to transfer 10% of their allowance to their taxpayer partner. This transfers £1,260 of tax allowance, boosting the recipient's tax-free allowance to £13,830 instead of £12,570. It saves approximately £252 in a single tax year, and can be backdated for four more years, paid by cheque.
HMRC's explanation via gov.uk says: "Marriage Allowance lets you transfer £1,260 of your Personal Allowance to your husband, wife or civil partner. Your Personal Allowance is the amount you can earn before paying tax. This reduces their tax by up to £252 in the tax year (6 April to 5 April the next year)." HMRC also stresses that it will not affect your application for Marriage Allowance if you or your partner are currently receiving a pension.
Rent-a-Room scheme
The second rule is the Rent-a-Room scheme, which applies to many state pensioners who may have spare bedrooms after their children have left home. Renting out a room allows you to earn up to £7,500 with no tax on the earnings. The scheme's allowance can only be applied to rooms being let in the property you live in, so it cannot be used to cover buy-to-let income.
You must declare it to HMRC as part of a self-assessment tax return. If you earn £7,500 or less from renting out a room, which is £625 per month, then you are exempt from paying any tax on that income.
By combining both allowances, you can enjoy the £12,570 Personal Allowance, add £1,260 through Marriage Allowance, and add another £7,500 from Rent-a-Room, bringing your total tax-free income to £21,330 completely legally.
