HMRC will send a new tax code letter to those eligible (Image: Getty)
State pensioners can increase their vital tax-free Personal Allowance limit by making use of two little-known but fully legal HMRC rules at the same time, if they are eligible.
Right now, the income tax Personal Allowance is still stuck at £12,570 and will remain frozen at that level until at least 2031, by which point it will have been sat at the same limit for a full decade, while earnings and indeed the state pension continue to creep up due to inflation and the triple lock.
After the Budget, Rachel Reeves confirmed that state pensioners who do not receive any other income apart from the state pension will be exempt from paying income tax if they exceed the threshold, which is due to happen in April 2027 following another triple lock increase.
But there are plenty of pensioners who will still be liable to pay tax on their pension and other earnings because they don’t rely solely on the state pension.
The state pension has always been taxable, but those who earned less than £12,570 never had to worry about it, as you don’t pay income tax on earnings below this Personal Allowance threshold.
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But with the state pension just £22 away from the threshold from this April, many who earn other income, such as savings interest, or are still in work, will exceed that threshold and, because they have other earnings, will not be exempt from tax.
However, there are two key HMRC allowances that can help with this: the Marriage Allowance and the Rent-a-Room scheme.
Married couples can boost their Personal Allowance by 10% thanks to Marriage Allowance, a legal tax reduction vehicle offered by HM Revenue and Customs.
Those who are married, or in a civil partnership, can transfer some tax allowance between one another in order to avoid some tax.
One of the couple needs to be a non-taxpayer, i.e. earning under the £12,570 allowance, and the other must be a 20% taxpayer, earning above it. This is a fairly common situation for pensioners, where, for example, one person has retired but the other is still working.
The non-taxpayer pensioner then applies to HMRC to transfer 10% of their allowance to their taxpayer husband/wife.
This transfers £1,260 of their tax allowance to their partner, boosting the recipient’s tax-free allowance by £1,260 to £13,830 instead of £12,570. It saves approximately £252 in a single tax year, and it can also be backdated for four more years, which is paid to you by cheque.
HMRC’s explanation via gov.uk says: “Marriage Allowance lets you transfer £1,260 of your Personal Allowance to your husband, wife or civil partner. Your Personal Allowance is the amount you can earn before paying tax.
“This reduces their tax by up to £252 in the tax year (6 April to 5 April the next year).”
HMRC also stresses that it ‘will not affect your application for Marriage Allowance if you or your partner are currently receiving a pension’.
Second, you can use HMRC’s Rent-a-Room scheme. This is applicable to many state pensioners who may have spare bedrooms after their children flew the nest, and will be able to rent out a room to a lodger in order to give their spending power a bit of a boost in old age.
Renting a room out allows you to earn up to £7,500 from letting out a bedroom in your home with no tax on the earnings.
The scheme’s allowance can only be applied to rooms being let in the property you live in, so you can’t use it to cover buy-to-let income.
You have to declare it to HMRC as part of a self-assessment tax return, and if you earn £7,500 or less from renting out a room (£625 per month), then you will be exempt from paying any tax on that income.
In this way you can enjoy the £12,570 Personal Allowance and add another £7,500 on top without paying income tax on any of it, completely legally.
In order to claim it, you need to fill out a tax return.
But by doing this and combining with the Marriage Allowance, you could boost your tax-free Personal Allowance all the way to £21,330.