Will Labour introduce a retirement tax?

Prime minister Rishi Sunak has repeated his claim that a vote for Labour means a vote for a retirement tax.

In the TV election debate last night, Sunak said that under a future Labour government “the state pension will be subject to a retirement tax”.

But what does this mean exactly? Are Keir Starmer and Rachel Reeves planning to introduce a new tax that will only affect the state pension?

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The Labour party have already committed to the state pension triple lock, as have the Conservatives.

So, pensioners have some certainty that their state pension will increase each April in line with inflation, average earnings or 2.5%, whichever is highest.

But how could their pension be taxed in future? And what about other pension tax issues, like the lifetime allowance, tax-free cash and pension tax relief?

We delve into the “retirement tax” issue and fact-check the Tories’ claim, and also look at what other pension decisions await the next government. 

Will Labour bring in a retirement tax?

A retirement tax sounds like a new tax policy that would target pensioners - but Labour have not announced anything like this.

So, it’s unlikely that Labour would bring in an explicit retirement tax. Although of course, political parties can (and do) introduce new policies that are not in their manifestos.

What the Tories are referring to when they say “retirement tax” is the fact the state pension will soon rise above the tax-free personal allowance.

The full new state pension is currently worth £11,502 a year. The personal allowance is £12,570. There are no plans to increase the personal allowance, but thanks to the triple lock, the state pension will rise each year by at least 2.5%.

The state pension is likely to breach the personal allowance by 2027-28, meaning retirees will have to pay income tax on part of their state pension.

The Conservatives have announced “triple lock plus” to get around this problem. If the party wins the election, they say they would introduce a new personal allowance for pensioners, which would rise in line with the triple lock - therefore keeping pace with the state pension and reducing the risk of pensioners being taxed.

Labour have not committed to such a policy. Last month, Starmer described the move as “desperate”, adding that it would leave a “Corbyn-style” black hole in the public finances.

What do pension experts think about the so-called retirement tax? 

The discussion around a retirement tax has arguably been a clever move by the Conservatives, getting older voters worried about what a Labour government could do to their pensions.

Helen Morrissey, head of retirement analysis at the wealth manager Hargreaves Lansdown, tells MoneyWeek that “it’s unfair to say that Labour would introduce a retirement tax if they win the election”.

She adds: “The Conservatives have upped the ante with the triple lock plus but it is a controversial policy which is seen as intergenerationally unfair and Labour have refused to match it on cost grounds. 

“The key issue is frozen tax thresholds that are pulling older people into taxpaying territory – numbers have risen by more than a quarter since the freeze was introduced. This can partly be down to more older people working and drawing a larger income but it is also the case that pensioners on smaller incomes are affected.”

Tom Selby​​​​, director of public policy at the investment platform AJ Bell, says the Conservatives “clearly tried to set a trap for Labour” with the triple lock plus and talk of a retirement tax.

He argues that “the very fact we have reached a stage where the full new state pension is closing in on the personal allowance is as a result of the current administration’s policy of freezing thresholds while maintaining the triple lock”.

Selby adds: “Furthermore, while Rishi Sunak claimed during last night’s debate that the state pension would be taxed for the first time, the reality is that the state pension has always been subject to income tax and there will be people who built up entitlements under the old system who have state pensions worth more than £12,570 already.”

Do pensioners pay tax on their state pension? 

While the full new state pension is currently below the personal allowance, plenty of retirees do already pay income tax on their state pension.

Former Lib Dem pensions minister Steve Webb suggests that almost 2.5 million pensioners pay income tax on their state pension - and would still be taxed even if the triple lock plus came into effect.

That’s because many people receive extra payments under the old state pension scheme.

New figures released today show that 6.7 million people of state pension age or over paid income tax in 2021/22. This is based on all of their income, so includes workplace and personal pensions and any work, on top of the state pension.

The figure is projected to have risen to 8.5 million in 2024/25 (a 26% increase) as more pensioners fall into the income tax bracket.

The increase in pensioner taxpayers is largely due to the substantial hikes to the state pension (it rose 8.5% this April, and 10.1% in April last year) and the frozen personal allowance. The tax-free allowance is set to stay at this level until 2028. 

But, of course, if the Conservatives lose the election, this could change.

What do Labour plan to do with pensions?

Labour haven’t said much about pensions, bar committing to the triple lock. However, it looks likely that some changes will be on the horizon if they win on 4 July, given the manifesto announced that a pension review would be coming soon.

The Labour document said: “We will undertake a review of the pensions landscape to consider what further steps are needed to improve pension outcomes and increase investment in UK markets.”

A review could potentially cover pension tax relief, and the 25% tax-free cash on pension withdrawals.

Pension savers currently get their marginal rate of income tax back as tax relief on their contributions. So, basic-rate taxpayers receive 20% tax relief, while higher-rate taxpayers get 40%.

Previous governments have looked at changing this attractive upfront tax relief. Suggestions have included making all tax relief 20%, or changing it to a flat rate of 33%.

The 25% tax-free cash policy could also come under the spotlight in a Labour review. To save money, a new government could lower the maximum level of tax-free cash to, say, 20%.

The Conservatives have ruled out changing pension tax relief and tax-free cash, but Labour haven’t made the same promises.

See How to protect your wealth from Labour for more on what the party is planning to do to taxes and personal finances - and what it could potentially do.

Will Labour reintroduce the lifetime allowance?

Chancellor Jeremy Hunt announced in March last year that the pension lifetime allowance would be scrapped, helping high earners and those with large pension pots avoid a tax charge of up to 55%.

At the time, Labour said they would look at reintroducing the allowance if they won the next election.  

However, the party seem to have backtracked on this, given that the allowance was not included in their manifesto.

Morrissey comments: “Labour’s stance on reinstating the lifetime allowance was not popular and threatened to bring extra complexity to people’s retirement planning. 

"The recent announcement that they were dropping this policy was greeted with a sigh of relief by those who felt their retirement planning was left in limbo.”