State pension could rise to £12,600 next year - dragging millions into paying tax

Retirees may have to pay tax on their state pension as early as next year, according to new forecasts.

The full state pension could soar by 5.5% to reach £12,631 a year in April 2026, due to the triple lock.

If this happens, it would breach the £12,570 tax-free personal allowance, and the excess would be taxed at the pensioner’s highest income tax rate.

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The triple lock dictates that the payment is increased each year by annual earnings, inflation or 2.5%, whichever is higher. The full new state pension is currently worth £11,502 a year, and will rise by 4.1% to £11,973 this April.

It was previously thought that the state pension wouldn’t be subject to tax until April 2027, according to Office for Budget Responsibility (OBR) forecasts released alongside the Autumn Budget.

But, analysis by Deutsche Bank suggests that strong wage growth will push the state pension up faster than expected.

Figures released this week revealed that wage growth in the UK hit 5.9% in the three months to December 2024. However, the state pension triple lock uses annual earnings in the three months to July, and it’s this figure that Deutsche Bank predicts could come in at 5.5%.

Sanjay Raja, Deutsche Bank’s chief UK economist, comments: “As of right now, our projection for average weekly earnings total pay in the three months to July sits at 5.5% year-on-year. Our September 2025 CPI inflation projection sits just around 4.25%.

“Therefore, based on our current projections we see state pensions rising by 5.5% in April 2026.”

Alice Haine, personal finance analyst at Bestinvest by Evelyn Partners, the online investment platform, tells MoneyWeek: “Paying tax on state pension income will feel very unfair, particularly for those who solely rely on the benefit to make ends meet. Making tax demands on retirees with no other sources of income will be extremely worrying for pensioners who are already struggling with higher living costs.”

She adds: “Meanwhile, those receiving a private pension income will simply see even more of that money swallowed up by tax as a result of frozen income tax thresholds.”

Ros Altmann, a former pensions minister, warns that making the state pension liable for tax could be an “administrative nightmare”.

She comments: “Many pensioners have never paid tax in their life. Those with private pensions or the younger ones who receive the new state pension and are not on the old [state pension] system may get a simple assessment form to help them know what tax and how to pay it.

“But the older ones would have to fill in a tax return. Can you imagine 90-year-olds being told they owe a few pounds in tax and must fill in a tax return, or face fines and penalties?”

Why will retirees have to pay tax on their state pension?

Millions of retirees already pay income tax because they receive extra money on top of their state pension, such as from a buy-to-let, part-time work or a personal or workplace pension.

But those receiving the full state pension and no other income in retirement – who would be regarded as some of the poorest pensioners – will also be dragged into the tax net if the payout rises above the personal allowance.

The £12,570 personal allowance is frozen at its current level until 2028, meaning each annual uprating to the state pension could increase the tax liability.

If the full state pension rose to £12,631 a year next April, as predicted by Deutsche Bank, the £61 above the personal allowance would be taxed. For a basic-rate taxpayer, this would create a £12 tax bill. For a higher-rate taxpayer, the bill would be £24.

The OBR previously forecast a 2.6% rise in the state pension for next April. It then said the state pension would increase to £13,230 a year by 2029.

If the freeze on the personal allowance was extended beyond 2028, and the 2029 OBR prediction was correct, it would mean the state payout would be £660 above the allowance in four years’ time. This would trigger a £132 tax bill for basic-rate taxpayers, while higher-rate taxpayers would need to pay £264.

Is the retirement tax unfair?

Former prime minister Rishi Sunak coined the term “retirement tax” on the election campaign trail last year after he claimed that a Labour government would subject the state pension to a "retirement tax”.

Sunak froze income tax thresholds until 2026 in the 2021 Spring Budget when he was chancellor. The freeze was later extended to 2028 by former chancellor Jeremy Hunt.

The Conservatives said it would introduce “triple lock plus” to avoid the state pension being liable for income tax. This was to be a new personal allowance for retirees, which would rise in line with the triple lock – therefore keeping pace with the state pension and reducing the risk of them being taxed.

However, Labour did not commit to such a policy, and now in government, it has not unveiled any measures to protect pensioners from tax as the state pension rises.

Clare Moffat, pensions and tax expert at Royal London, notes: “The previous government had set out proposals to avoid any income tax being paid on the state pension, but it is unclear whether those will be revisited. It would make little sense to have a situation where the state is paying you an increased pension on one hand but taking some of it back in tax on the other.”

According to Royal London, the most recent data from HMRC shows there’s been an increase of two million over-65s paying tax since 2020/21, and “that would rise substantially if the state pension increased to over £12,570”.

Haine says if the state pension rose above the personal allowance it “could put pressure on the government to unfreeze the personal allowance to prevent retirees being taxed on this vital benefit or reconsider whether more radical action is needed”.

A Treasury spokesperson said: “The state pension is the foundation for ensuring pensioners are able to live with the dignity and respect they deserve.

“We are committed to the triple lock, and pensioners whose sole income is the new state pension and who have not deferred or receive protected payments do not pay any income tax.”