Chancellor John Healey is reportedly considering a Budget measure that would give pensioners a higher personal allowance if they spend their pension and other taxable savings quickly, a move critics warn could create perverse incentives in retirement planning.
The reported aim is to protect low-income pensioners from paying tax as the state pension rises above the frozen £12,570 personal allowance for the first time. From next April, a 3.9% triple lock increase looks set to lift the full new state pension to £13,036 a year, some £466 above the frozen allowance, making it directly taxable for the first time.
Higher allowance for some, not all
Healey's reported work-around would raise the personal allowance to the same level as the state pension. However, the higher allowance appears likely to apply only to pensioners whose sole income is the state pension. Anyone with additional income from a personal or workplace pension, taxable savings or a part-time job would remain on the frozen £12,570 allowance.
This would punish people for doing what successive governments have encouraged: saving for retirement rather than relying entirely on the state. While the higher personal allowance would continue to rise with the state pension, the lower one would not. Insurer Standard Life estimates that the cumulative tax saving could reach £770 by April 2031, when the personal allowance freeze is due to end. Around a million people would benefit, while millions would miss out.
Incentive to draw down savings
Under the reported rules, even a penny of additional income could kill eligibility for the higher personal allowance. The proposal could also encourage some people to draw down their pension savings faster than they otherwise would, in the hope of qualifying for the higher allowance.
Some could rush to withdraw large sums, which could backfire if a large withdrawal pushes them into a higher income tax band that year. Once spent, that money is gone. Retirement can last 20 or 30 years, bringing rising household bills, home repairs and potentially expensive care costs. Running down savings too soon could leave pensioners relying on family or means-tested benefits later in life.
Risk of greater benefit dependence
Eligibility rules have yet to be confirmed, so it is not known whether even a small amount of extra income would automatically disqualify someone. But the danger is clear: pensioners who deliberately run down their savings may become more dependent on means-tested benefits, funded by the taxpayer.
A tax system should encourage people to provide for their own retirement, not give them another reason to spend the money before they need to, then claim even more from the state. If Healey presses ahead, he will be punishing pensioners for doing the right thing while actively encouraging them to do the wrong one.
