Will Labour introduce a retirement tax?

As the Labour government prepares to deliver their first Budget next month, many retirees will be bracing themselves for further pension shocks.

The new government has already scrapped the winter fuel payment for millions of pensioners, and prime minister Keir Starmer has warned that the Budget will be "painful" with more "difficult decisions" to come.

There is speculation that the state pension could be means-tested, while savers could see their pension tax relief cut.

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These are just rumours at this stage - others include hiking fuel duty and capital gains tax.

Pensioners will be pleased to know that the state pension triple lock should remain in place at least, with the full new state pension forecast to rise by more than £400 a year in April.

However, a rise in the state pension also brings back memories of former prime minister Rishi Sunak's repeated claims that a Labour government would subject the state pension to a "retirement tax”.

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

We delve into the “retirement tax” issue and fact-check the Tories’ claim, and also look at what other pension decisions the Labour government could take to plug the fiscal black hole that they claim they inherited from the Conservatives.

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 they would bring in an explicit retirement tax. Although of course, political parties can (and do) introduce new policies that are not in their manifestos after forming a new government.

What the Tories are referring to when they say “retirement tax” is the fact the state pension could 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%.

With a predicted rise of more than £400 a year next April, the full new state pension will reach about £12,000 - and 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 previously announced “triple lock plus” to get around this problem. They said that if they won the election, 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. Starmer previously described the move as “desperate”, adding that it would leave a “Corbyn-style” black hole in the public finances.

We should hopefully see a mention of the state pension in Rachel Reeves's first Budget on 30 October.

It will likely confirm the government's commitment to the triple lock - but it's not clear if the situation of retirees paying tax on their state pension will also be included.

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

The discussion around a retirement tax was arguably 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, previously told MoneyWeek that it was "unfair to say that Labour would introduce a retirement tax if they won 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 tax-paying 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 says that now Labour are in power, they will need to be "mindful of the state pension tax iceberg that is looming into view", with the full new state pension set to exceed the personal allowance in the coming years. 

“While there are already pensioners who built up entitlement under the pre-2016 system paying income tax on their state pension today, Keir Starmer will doubtless want to avoid the symbolism of the full state pension being subject to income tax.”

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 Tories' triple lock plus policy had come into effect.

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

About 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.

What does Labour plan to do with pensions?

The Labour government says it will undertake a review of the pensions landscape 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, the new government could lower the maximum level of tax-free cash to, say, 20%.

The Conservatives ruled out changing pension tax relief and tax-free cash in the run-up to the general election, but Labour haven’t made the same promises.

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.”