The government proposal of exempting certain pensioners from income tax risks creating new unfairness and complexity, according to former pensions minister and LCP partner Steve Webb.
At present the standard rate of the new state pension is set to rise to £241.30 per week or £12,547 per year in April 2026 - just below the tax threshold of £12,570. However, assuming a minimum 2.5% increase in April 2027 (in line with the triple lock), the pension would rise to £247.35 per week or £12,862 per year – above the tax threshold. Someone with just this income would have taxable income over the threshold of £292 per year, and would therefore have a tax bill of around £58.
Such a sum would normally be collected by the ‘Simple Assessment’ process where HMRC does all the calculations and sends the pensioner a tax demand at the end of the year.
The Chancellor has said that HMRC will not collect the tax in this situation and will not do so in 2028/29 and 2029/30 either.
But Webb says this proposal raises several questions of fairness:
a) What about people on the ‘old’ state pension who make up the majority of pensioners?
There are currently around 2.5m pensioners on the old system whose state pension on its own is already over the tax threshold. "Why has nothing been done for them so far?", Webb asks. What will happen to people whose total state pension under the old system (basic pension plus SERPS pension) is exactly the same as the rate of the new state pension – will they be exempt as well? And what if they are a pound above – do they continue to be taxed?
b) What about people with small private pension income?
The Government has said that this exemption would only apply to people with no other income aside from the state pension. So would someone with £5 per week of private pension income face full taxation, but someone without would pay no tax? Will this result in some people choosing to cash out their small private pensions rather than turn them into income which could cause them to lose the tax exemption?
c) What about workers on exactly the same income?
It is being proposed that a pensioner on (say) £12,862 should pay not tax, but an employee on exactly the same income would not get such an exemption – they would pay both tax and NICs on their wage – why?
Steve Webb, partner at pension consultants LCP, said: “The Government has a clear presentation problem when the new state pension goes above the tax threshold in 2027. But millions of pensioners already get state pensions above the tax threshold and nothing has so far been done for them. So there is a real risk that pensioners on the new system will be more favourably treated. The new scheme also risks penalising people with small private pensions who will not be protected compared with those who have no private pension who will be protected. This penalises those who have saved, even modest amounts. And the new rules will mean that a pensioner just above the tax threshold will pay no tax whilst an employee on exactly the same income will pay both tax and NICs which seems unfair.
“There is no costing for this policy in the Budget documents which suggests that it is still very much an idea rather than a firm plan. But it will be incredibly difficult for the Treasury to come up with something that is workable and fair”
