In his speech to Labour’s annual conference in Liverpool last month, Andy Burnham repeated a promise that “low-income pensioners won’t be dragged into paying income tax in this Parliament”.
It built on previous assurances – including from the pensions minister Torsten Bell – that people wholly dependent on the state pension “will not have the administrative burden of paying small amounts of tax in this Parliament”.
While the Government has been adamant that retirees in this situation will not have to pay income tax, it is still not clear what mechanism will be used to exempt them, with the Treasury promising to set this out in the Budget on 28 October.
Experts have told The i Paper that there are several workarounds which could be used. However, it is worth briefly revisiting why the Government is having to do this in the first place.
The state pension tax trap
Because of the triple lock – under which the state pension increases each year in line with the highest of inflation, earnings or 2.5 per cent – the state pension is set to climb to £13,036.40 in April.
This will mean that for the first time it will exceed the income tax personal allowance, which stands at £12,570.
If no change occurred, a retiree whose sole income is the state pension would have to pay income tax of about £93.
However, in last year’s Budget, former chancellor Rachel Reeves said that income tax would not be levied on people in this position – a commitment which Burnham’s Government decided to stick to.
In terms of how the commitment could be delivered, there are several options at Healey’s disposal.
Raising the personal allowance for everyone
In some ways the most straightforward approach would be to increase the personal allowance for everyone. Lifting the allowance to £13,036.40 would ensure that low-income pensioners would be exempted. However, it would represent an across-the-board tax cut which would be hugely expensive for the Treasury.
Recent chancellors have frozen the personal allowance and other income tax thresholds precisely because it is a highly effective way of raising huge amounts of revenue without the bad headlines of a tax rise.
Rishi Sunak first announced in March 2021 that inflation uprating of income tax thresholds would be suspended and the allowance frozen at its April 2021 level of £12,570, with his successors Jeremy Hunt and Reeves continuing the freeze. The latter made a decision to freeze the personal allowance until April 2031.
Likelihood rating (out of 5): 0, for now
While Burnham has previously spoken of his desire to raise the allowance, Britain’s straitened financial circumstances and the Government’s commitment to stick to its fiscal rules mean that this is not currently realistic. For this reason, there will be no announcement on 28 October that the personal allowance will be uprated in line with the state pension.
Robert Salter of tax specialists Blick Rothenberg told The i Paper: “The Government could increase the personal tax allowance for all taxpayers rather than purely for pensioners. However, whilst this option would in many respects be ‘fairer’, given that an increase in the personal tax allowance for all taxpayers from £12,570 to say £14,000 per annum would cost the Government perhaps £12bn, this is not a practical option for the Government at this stage.”
However, with Burnham on record as wanting to raise the allowance and scrap the triple lock, it is more than possible that this will be the long-term solution after 2031.
Self-assessment
A slightly more credible option would be to require pensioners solely dependent on the state pension to file self-assessment tax returns. However, Reeves ruled this out when she was chancellor.
“We are not going to make you fill in a tax return,” she said last November. Blick Rothenberg said that requiring pensioners in this situation to file tax returns would be “disproportionate given the levels of income involved” and that “HMRC simply do not have the resources to manage the additional Self-Assessment records”.
Likelihood rating: 0. In addition to the above problems, making elderly people fill in complex online tax returns would be deeply unpopular.
An age-related personal allowance
Blick Rothenberg have said that the commitment could be delivered instead via the “straightforward change” of re-introducing an “age-related personal allowance”. Before 2013-14, individuals were entitled to claim one of two age-related additions to the personal allowance if they were 65 years of age or older. However, former chancellor George Osborne phased these out during the Tory-Lib Dem coalition government.
Salter said: “The Government could introduce an enhanced personal tax allowance specifically for pensioners (and pensioners have historically been eligible for a higher personal allowance than regular taxpayers).
However, he said the downside of this option would be that it could mean that wealthier pensioners – such as those with large private pension pots – “might be benefiting from the enhanced tax allowance”, meaning it would be “more expensive for the Government”.
Likelihood rating: 3. This would be the cleanest long-term option, although it would mean the Treasury having to stomach wealthier pensioners not paying as much tax. A workaround to this would be to include a taper so that tax was paid on an incremental scale as income increased.
Not collecting the tax
The final option – and perhaps the most likely – would be for the Government to “opt out” of collecting the tax from relevant pensioners.
Normally, HM Revenue and Customs collects small tax sums via a process called “Simple Assessment”, in which it carries out the relevant calculations itself and sends someone a tax demand at the end of the year.
Sir Steve Webb, a former pensions minister who is now a partner at the pensions firm LCP, told The i Paper last month that the Government could “simply block the letters” from being sent to pensioners owing the £93 in tax which would otherwise be due.
“It’s a relatively simple message to say that any pensioner owing under £100 simply won’t get a tax demand,” he said. “Of course, next year it will be more than that, and the following year more still.”
Salter said: “The Government could simply ‘opt out’ of collecting the tax on state pensions for ‘qualifying cases’.
“This was Ms Reeves’ apparent preference when she was Chancellor, albeit her proposals in this regard would appear to have been quite limited and could have meant that a number of poor pensioners would still have been caught by a tax charge on their pension (e.g. if they also had very limited amounts of bank interest on top of their basic or new state pension).”
Likelihood rating: 4. A simple option. But may not be tenable in the long term as pensions increase.
Ensuring fairness
Whatever happens, charities for older people are urging the Government to tread carefully. Caroline Abrahams, charity director of Age UK, told The i Paper: “The state pension rising above the tax threshold has the potential to cause a lot of headaches, both for politicians and for the individuals affected.
“Although the tax system is rarely perceived as ‘fair’ by anyone, this will affect pensioners on low incomes and it’s important we don’t put them at a particular disadvantage.”
She added: “We need to make sure the system works for everyone and treats people of all ages fairly. Tax thresholds have been frozen since 2021 and are expected to remain so until at least 2031. This issue will continue to grow, affecting more and more pensioners, and while there’s no easy solution, we believe that the best and fairest way forward is to change policy and raise the income tax threshold for everyone.”
Pensions minister Torsten Bell said: “In line with the commitment made at Budget 2025, pensioners who only just exceed the personal allowance will not have the administrative burden of paying small amounts of tax in this Parliament. The Chancellor will set out further details on how that commitment will be delivered at the Budget.”