The Chancellor has confirmed that the state pension will increase by 4.8% next year, in line with wage growth and well above the rate of inflation. Thanks to the triple lock, the full state pension will increase from £11,973 to £12,547 a year from April 2026. Not everyone receives the full amount, but for those who do, the increase brings them within £23 of the basic rate income tax threshold.
That threshold, currently £12,570, has been frozen since 2021. With Rachel Reeves warning of a £30 billion fiscal gap, widespread expectations are that the freeze will be extended to 2029 to help raise revenue. If so, the subsequent rise in the state pension will cause many pensioners to enter the income tax bracket for the first time.
From 2027 to 2028, even those relying solely on the full state pension will have a tax liability. This will present HMRC with a significant operational challenge, as there is currently no direct way to deduct income tax from state pension payments. Currently, tax on retirement income is collected through private and workplace pensions.
Unless the Government introduces taxation at source for state pensions, HMRC will need to send payment demands to pensioners who owe tax.
The administrative costs of issuing and processing thousands of tax demands could offset some of the revenue raised. Although waiving very small tax bills has been suggested, frozen thresholds mean liabilities will increase each year, making any widespread waiver less feasible.
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