Millions of pensioners to face higher tax burden

11 October 2024

Written by Retirement Line

A substantial number of UK pensioners are on course to be caught in higher tax brackets due to the government’s decision to freeze income tax thresholds. The financial impact is set to grow more severe in the coming years. 

According to recent data, around 3.1 million pensioners will be subject to higher or additional rate tax by the 2027/28 tax year. This change is largely attributed to the prolonged freeze on tax thresholds. This policy was introduced under the previous Conservative government and is projected to continue until at least 2028.

It equates to an additional one in five pensioners being dragged into a higher or additional rate of tax, according to the report in Money Marketing, which features HMRC data obtained through a Freedom of Information request.

The policy of freezing income tax thresholds, which determine when individuals begin paying higher tax rates, has led to what some experts describe as "taxation by stealth". This is because, as inflation and wages rise, more pensioners are being inadvertently drawn into higher tax bands. 

State Pension rise sees more liable for tax

A key cause for concern is the new State Pension. This rose by 8.5% in April 2024 – a £902 increase for those receiving the full amount – raising the annual new State Pension income from £10,600 to £11,502. This pushes some pensioners with other income sources above the £12,750 personal allowance, thereby making them liable for income tax for the first time.  

It means that, with only £1,068 left before surpassing the personal tax threshold, individuals with additional monthly income of £89 or more, on top of their full State Pension, may face a tax bill next year. 

For those receiving the full Basic State Pension, the weekly payment is £169.50, which totals £678 every four weeks. Over the 2024/25 financial year, this reflects a £692 increase, bringing the annual income from £8,122 to £8,814. This leaves £3,936 before the personal tax threshold is reached – £328 or more per month.

According to the Daily Record, some 8.1 million pensioners currently pay tax in retirement, typically due to additional income on top of their State Pension from workplace or private pensions.

Adam Pope from Spencer Churchill Claims Advice said: “As the State Pension amount goes up, more pensioners could have to pay more tax, making life harder for those already struggling. Over 60 per cent of pensioners are paying income tax, up from about 50 per cent in 2010.

“What’s more, keeping income tax thresholds the same could mean pensioners have less money to spend. By 2027/28, the average tax-paying pensioner could be £1,000 worse off which could really affect their living standards and financial safety.”

Number of pensioners paying income tax surges to nine million

The income tax personal allowance and higher rate threshold are at £12,570 and £50,271 respectively. Additionally, the 45% tax bracket was lowered from £150,000 to £125,140 in 2023. If these remain unchanged indefinitely, it could lead to a further increase in the number of individuals paying taxes or facing higher tax rates. This is a phenomenon known as ‘fiscal drag’.

The situation has already prompted action from HM Revenue and Customs (HMRC), which has begun issuing tax demands to pensioners affected by recent changes in the personal allowance and tax thresholds. An estimated 140,000 pensioners have either received or will soon receive letters informing them of their new tax obligations. 

It means the number of over-65s paying income tax has surged from 4.9 million in 2010/11 to nearly nine million expected in 2023/24.

Former pensions minister, Steve Webb, said: 

“It is rarely good news to receive a letter from HMRC and in this case 140,000 pensioners will be getting a tax demand in the next few weeks for the first time since they retired.

"The size of the bill will often be relatively small at first, but this could grow year-on-year if the current policy of freezing tax thresholds continues."

Analysis by Quilter also reveals that in the period 2022-23 to 2027-28, nearly 2.7 million individuals aged 60 and over will be subject to the 40% higher tax rate. Almost half a million more will find themselves in the 45% additional rate. 

Experts issues warnings to older savers

Financial advisers are urging pensioners and those nearing retirement to take proactive steps to manage their finances. Jon Greer, head of retirement policy at Quilter, advises pensioners to consider maximising their pension contributions as a way to reduce their taxable income. 

He said: “Pensions provide the most tax-efficient way of saving for retirement, so it is important that people are aware of their annual allowance amount and that all who can afford to utilise it do so.

“For those who are already withdrawing from their pension, it is important to only take as much money as you need each tax year as the less you withdraw, the less income tax you will pay.”

Sources:

Around 3.1 million pensioners will be subject to higher or additional rate tax by the 2027/28 tax year, and Quilter analysis for higher tax rate:One in five pensioners will be ‘dragged’ into paying higher rate tax. Money Marketing. Accessed 8 October 2024.

Some 8.1million pensioners currently pay tax in retirement, and Adam Pope quote:Nearly 9 million people over State Pension age due to pay tax next year. Daily Record. Accessed 8 October 2024.

HMRC issuing 140,000 tax demands to pensioners affected by changes in the personal allowance:Warning as 140k pensioners to pay tax for first time. FT Adviser. Accessed 8 October 2024.