The chancellor has promised a tax break for those who rely on the state pension, in a move that critics warn will create a two-tier retirement regime.<\/p>\n
The full state pension will be liable for income tax when the triple lock pushes it above the personal tax-free allowance in 2027. But Rachel Reeves<\/a> has said that HM Revenue & Customs (HMRC) will not tax those who rely solely on the state pension. <\/p>\n The former pensions minister Steve Webb has warned that this will create a two-tier system that will penalise those who set aside money for retirement and will bring \u201call sorts of unwelcome side-effects\u201d. Experts have also warned that the chancellor\u2019s plan would mean the state pension was effectively means-tested<\/a> because those with retirement savings would receive less of it.<\/p>\n From April the new full state pension will increase to \u00a312,548, taking it to \u00a322 shy of the income tax threshold of \u00a312,570. Given that the triple lock guarantees that the state pension will increase by 2.5 per cent (unless earnings growth or inflation is higher), it is guaranteed to increase to at least \u00a312,862 by April 2027. This puts it \u00a3292 above the income tax threshold and could mean some pensioners need to hand back \u00a358 in tax if they are a basic-rate taxpayer or \u00a3117 if they pay the higher rate. <\/p>\n There are 13.1 million people collecting a state pension, according to the Department for Work & Pensions, and figures from HMRC show that 8.72 million already pay income tax. And it may not be as simple as exempting some pensioners from paying any tax. Here, Times Money takes a look at the flaws of the retirement tax raid.<\/p>\n Older pensioners pay more<\/p>\n Someone on the basic state pension who reached retirement age before April 2016 will see their payments increase to \u00a39,615 from April. But many already receive an income over the personal allowance \u2014 2.5 million in fact, according to figures from the consultancy LCP. And there are no allowances for them to get out of income tax. <\/p>\n This is because while someone on the basic pension receives \u00a3176.45 a week, they can also claim another payment (the additional state pension), which is \u00a3222.10 a week. This could give them an overall income of \u00a320,724 a year, which is more than \u00a38,000 above the threshold. If they received the maximum amount they would have a tax bill of \u00a31,631 a year, although it is worth noting that in this instance they received more income in the first place than someone who retired under the newer system. <\/p>\n But it does mean changes to the system could be seen as unfairly benefiting newer retirees, said the wealth manager and financial planner Carl Mba, because while someone receiving only the new state pension would pay no tax, someone receiving basic state pension plus the additional state pension, or a small private pension, would. <\/p>\n \u201cIt seems fundamentally unfair that two people living on very similar incomes can be treated so differently,\u201d he said. \u201cIncome is income, people are people, and the cost of living is the cost of living, regardless of where your \u00a31 comes from.\u201d<\/p>\n \u2022 How to solve the state pension problem: the options for reform<\/a><\/p>\n Punishing prudence<\/p>\n The government has said the exemption will apply to people with no income apart from their state pension, but this risks creating a \u201ctwo-tier system\u201d where those who set aside money for their retirement could be penalised. <\/p>\n \u201cThis new proposal creates all sorts of unwelcome side-effects,\u201d Webb, now a partner at LCP, said. \u201cIn particular it seems very unfair to offer a \u2018tax amnesty\u2019 to people who have no private pension income but to take it away if people have even a tiny private pension. <\/p>\n \u201cAt a time when the government apparently wants more people to save for their retirement, punishing people for small amounts of pension saving sends the wrong signals entirely.\u201d<\/p>\n The new rules will \u201ccreate inequality and ultimately enable people to \u2018game\u2019 the system,\u201d said Nick Nesbitt, the head of private client at Forvis Mazars accountancy firm. One of his clients, who has a \u00a324,000 state pension after inheriting some of her husband\u2019s entitlement, loses approximately 50 per cent of her \u00a35,000 private pension because the tax due on her state pension is reclaimed from this private pot.<\/p>\n \u201cMoving forward, if this were a drawdown arrangement she could choose not to draw her private pension income, perhaps instead rely on savings, and ultimately save 20 per cent income tax on the roughly \u00a311,500 of that state pension that sits above the personal allowance. This deprives the government of around \u00a32,300 per annum of tax take.\u201d<\/p>\n These situations are rare, he said, but lower earners who have worked to save a modest private pot will \u201csuffer more tax on their state pension than those who simply haven\u2019t bothered to save for their own retirements\u201d.<\/p>\n Unfair for workers<\/p>\n As well as creating a divide, there is a \u201cbroader fairness question here\u201d, Lily Megson-Harvey from My Pension Expert said. A lower-income worker who earns just above the personal allowance threshold has to pay tax while someone who receives only the state pension does not. <\/p>\n \u201cIf two individuals have the same income, one from work and one from a mix of state and private pensions, they could face very different tax treatment,\u201d she said. \u201cWhile protecting vulnerable pensioners is vital, the system should also feel equitable across generations.\u201d<\/p>\n