The UK Treasury is reportedly considering plans to tax the state pension before it is paid out to retirees. Chancellor Rachel Reeves is collaborating with the Department for Work and Pensions (DWP) on proposals that would involve deducting income tax from state pension payments before they are disbursed.
Currently, pensioners whose income exceeds the personal allowance of £12,570 may be required to file a tax return and pay income tax after receiving their pension. The proposed change aims to address the imminent breach of this tax-free allowance, as the annual state pension is projected to exceed £12,570 by April next year. This situation, exacerbated by the freezing of the personal allowance since 2021 and the annual increases to the state pension under the triple lock mechanism, is known as fiscal drag. Even a minimum 2.5 percent increase in the state pension under the triple lock would raise annual payments to an estimated £12,860, potentially subjecting low-income pensioners to tax bills for the first time.
Historically, the full new state pension has remained below the tax-free threshold. In April, it rose by 4.8 percent to £12,547. This annual increase, protected by the triple lock, is determined by the highest of the previous September's consumer prices index (CPI) inflation, average earnings growth, or 2.5 percent. Consequently, many pensioners relying solely on the state pension have been exempt from income tax. However, with the pension payments nearing and expected to surpass the frozen personal allowance, individuals receiving only the state pension would only need an additional £23 annually from other sources to trigger a tax bill.
Reports suggest that one discussed option involves deducting tax at the basic rate of 20 percent from all state pension payments. This amount would then be reconciled at the end of the tax year against the total tax owed, considering other income sources. Such a move could potentially affect those on the lowest incomes, including vulnerable pensioners who rely exclusively on the state pension. This possibility appears to contrast with previous assurances from Chancellor Reeves that those surviving solely on the state pension would not be required to complete tax returns during this parliamentary term and would not have to pay the tax. Neither the Treasury nor the DWP has officially confirmed the details or operational mechanisms of such a plan. A DWP spokesperson stated that there has been no change to the tax treatment of the state pension and that the government routinely researches pensioners' experiences with the tax system.