Thousands of pensioners to be dragged into income tax net due to state pension boost

An extra 650,000 pensioners will have to start paying income tax as a result of next April’s 8.5% state pension increase

gold nest egg
(Image credit: Getty Images)

Thousands of pensioners will have to start paying income tax due to the massive rise in the state pension next April. 

The state pension will jump by 8.5%, as confirmed by the chancellor in his Autumn Statement. This means the full new state pension - paid to those who reached state pension age after April 2016 - will increase by more than £900 a year to £11,502.

The basic state pension will rise to £8,814.

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The bumper increase next year is thanks to the triple lock mechanism, which guarantees an annual increase in the state pension of 2.5%, wage growth or inflation - whichever is higher.

While pensioners and those approaching retirement will be cheering the 8.5% rise - the second-biggest increase to the state pension - many will be dragged into the income tax net and will have to start paying tax on their income.

“Alongside a continued freeze of the tax-free personal allowance, the big rise in the state pension is likely to drag well over half a million more pensioners into the income tax net. Once again, ‘stealth’ taxation proves a convenient revenue raiser for the chancellor,” comments Steve Webb, partner at the consultancy LCP, and a former pensions minister.

 The pensions tax trap 

The personal tax threshold will be frozen again at £12,570 next year. This means pensioners receiving the full annual state pension of £11,502 will only need a small amount of extra income - such as from a personal pension, workplace pension, or part-time earnings - to be dragged into the tax net.

To be precise, the state pension will take up 92% of the personal allowance, with pensioners just needing an additional £1,068 of income to cross the tax threshold.

Dean Butler, managing director for retail direct at Standard Life, notes: “The personal allowance has been frozen since 2021/2022 and currently remains fixed for quite a few years to come. This means the full state pension payment has grown from 70% of the allowance in 2019/20 to 92% next year.”

How many people will be affected?

Between 2022-23 and 2023-24, HMRC figures suggest that the number of those aged 65 and over who pay income tax rose from 7.73m to 8.5m, due to the 10.1% increase in the state pension in April 2023.

According to LCP, a further rise of 8.5% in the state pension will likely result in an extra 650,000 pensioners paying tax, taking the total to 9.15m in the 2024-25 tax year. In contrast, only about 4.5m over-65s paid income tax in 2010.

Jason Hollands, managing director at the wealth management firm Evelyn Partners, remarks: “Anyone with even a very modest private income will be tipped into paying basic-rate tax at 20% next year.”

In fact, there will only need to be a few more small increases to the state pension in future for it to breach the personal tax allowance - throwing all retirees that receive the full new state pension into the tax net.

Hollands explains: “In the next three years it will require triple-lock increases of just a sliver greater than 3% to take the annual state pension above the annual personal tax allowance.”

He adds that this would present a conundrum for the government: they could either “create an administrative and political headache by taxing the state pension, possibly at source – which would be massively unpopular among the more than 13 million people then expected to be of state pension age - or make the headache go away by raising the personal tax allowance for everyone”.

Should I still save into a pension? 

The idea of paying tax on your retirement income due to a large jump in the state pension may make you think twice about building up a big private pension.

While saving into a pension attracts tax relief, when you come to take money out it is liable for tax.

Hollands notes that pension saving can still be very tax-advantageous, particularly if a saver is a higher or additional-rate taxpayer in their working life but then a basic-rate payer when they draw on their pension.

However, he adds that a soaring state pension “does serve to remind today’s savers of the value of ISAs, which can provide a valuable supplementary income to pensions during retirement that is not taxed at access. Although contributions to ISAs for most people will be made from taxed income".

Ruth Emery
Contributing editor

Ruth is an award-winning financial journalist with more than 15 years' experience of working on national newspapers, websites and specialist magazines.

She is passionate about helping people feel more confident about their finances. She was previously editor of Times Money Mentor, and prior to that was deputy Money editor at The Sunday Times. 

A multi-award winning journalist, Ruth started her career on a pensions magazine at the FT Group, and has also worked at Money Observer and Money Advice Service. 

Outside of work, she is a mum to two young children, while also serving as a magistrate and an NHS volunteer.