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Pension increases by 4.1%, resulting in taxation for numerous thousands of individuals

Enhanced State Pension Due to Triple Lock, Yet Frozen Tax Bands Lead to Higher Taxation for More Pensioners

Higher state pension due to triple lock, yet freeze on tax thresholds leads to more seniors facing...
Higher state pension due to triple lock, yet freeze on tax thresholds leads to more seniors facing taxation.

Pension increases by 4.1%, resulting in taxation for numerous thousands of individuals

State Pension Increase Boosts Income for Millions, but Pushes Some into Tax Net

The state pension has witnessed a 4.1% increase, benefiting 12 million individuals in retirement, yet the freeze on tax thresholds has led to hundreds of thousands of pensioners being pulled into the tax bracket.

The new full state pension now amounts to £11,973 annually or £230.25 per week, signifying additional income for affected retirees. However, those with a combined annual income exceeding £597, including both private and workplace pensions or earnings, will surpass the tax-free personal allowance of £12,570, triggering tax liability.

Steve Webb, former pensions minister and partner at pension consultancy LCP, anticipates 350,000 more pensioners will contribute tax this fiscal year compared to 2024/25, with 650,000 retirees paying income tax solely on their state pension this tax year.

Webb emphasizes the impact of the repeated freeze in the personal allowance for income tax and the substantial state pension increases, resulting in more pensioners now paying income tax. He forecasts that the trend will continue, with more pensioners being dragged into the tax net this year and facing year-end tax demands from HMRC if they lack additional pension income with a tax code for collection purposes.

The personal allowance bust is expected to accelerate if income tax thresholds remain unadjusted, with the full new state pension following the tax-free allowance as early as 2027. The Office for Budget Responsibility (OBR) forecasts a 4.6% increase in the state pension next year, which would raise the full new state pension to £12,569.85 annually, just 15 pence short of the tax-free allowance, according to Quilter.

The tax cliff edge for pensioners is approaching, as Greer at Quilter notes. The OBR's forecasts suggest the state pension will climb to £12,885.50 a year in 2027/28, surpassing the personal allowance by £315.50. Prior to the general election, the Conservatives promised to enhance the personal allowance for pensioners, yet this commitment was abandoned following the election.

Although not everyone's state pension benefits from the triple lock, some retirees already pay tax on their state pension income. Approximately 2.5 million pensioners tax their state pension, as LCP estimates, due to delayed retirement age or larger amounts of additional state pension. As pensioners often receive additional income from workplace or private pensions, a significant portion pays income tax, with the burden growing due to fiscal drag.

According to HMRC, around 8.51 million pensioners are tax-liable in the 2024/25 tax year, with 660,000 additional pensioners being taxed compared to 2023/24. Pensioners currently paying basic tax rates on their pension may find themselves in higher tax bands due to the growth of the state pension, potentially leading to unexpected tax demands from HMRC if tax codes for pension income are not properly managed.

Moreover, 21 million British individuals aged 21-65 remain unaware that the state pension is taxable, according to Royal London pensions expert Clare Moffat. Consequently, many retirees receiving additional private or workplace pension income may experience a reduction in their monthly income due to tax deductions.

Retirees with additional income sources beyond the state pension are at risk of facing higher tax liabilities. It is essential for retirees to remain informed about their state pension taxation and plan their retirement income accordingly to minimize potential tax burdens.

The new increase in the state pension has led to a rise in personal income for millions of retirees, yet it has also caused an increase in tax liability for some, pushing them into the tax net.

Moreover, the substantial state pension increases combined with the frozen personal allowance for income tax means that more retirees are now paying income tax.

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