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Why half a million state pensioners may start paying income tax after the budget - YAHOO FINANCE
An extended freeze on the income tax threshold, which Rachel Reeves is reportedly considering, could push more pensioners than ever into paying tax
An additional half a million state pensioners could start paying income tax if chancellor Rachel Reeves extends the freeze on tax thresholds for another two years, new analysis suggests.
That's according to modelling by Steve Webb, a parter at pensions consultants LCP and former Liberal Democrat pensions minister.
It means the number of state pensioners paying income tax will rise from around 8.7 million today to around 9.3 million, representing three-quarters of all pensioners, Webb's research suggests.
There is potential for the number of tax paying pensioners to rise further to 10 million by the end of the decade, depending on how much inflation and wage growth change in the coming years.
Having abandoned plans to increase income tax, Reeves is expected to instead extend the freeze on income tax thresholds at her Autumn budget on Wednesday (26 November) – a practice often described as a "stealth tax" by critics.
How will this affect 500,000 pensioners?
Webb, who served as minister of state for pensions in the Tory/Lib Dem coalition government, says half a million pensioners will have to start paying income tax if the threshold remains frozen.
He says this will be the case even allowing for the increase in pension age from 66 to 67.
The majority of pensioners today retired under the old state pension system, 2.5 million of whom already have a pension that takes them above the income tax threshold.
"But from 2027/28, anyone on the full rate of the new state pension will also be above the tax threshold based on their state pension alone," Webb said.
The impact on people under the new state pension will be greater, modelling suggests, as around half a million people under this system are already over the tax threshold as a result of their pensions.
An extended freeze will not only push people over the starting point for basic rate tax, but also the threshold for 40% and 45% tax, Webb said.
This year, just over 1 million pensioners will pay tax at 40% or above, compared with just under half a million four years ago, he added.
One way the government uses to increase its income tax revenues without actually raising the tax is by freezing the thresholds – a tactic described by some critics as a "stealth tax".
This phenomenon is also known as "fiscal drag", as more taxpayers are "dragged" into paying tax, or paying at a higher rate as wages rise, even if they aren't feeling the benefit of their pay rises due to inflation.
Looking back at when the current freeze started in 2021/22, the new state pension was around three quarters of the tax threshold, and the gap has been steadily narrowing since.
"In 2027/28, even with just a 2.5% ‘triple lock’ increase in the state pension, the new state pension will be 102% of the tax threshold; in 2021/22 there were around 6.7m pensioners paying tax compared with 8.7m today," Webb said.
"If inflation or wage growth picks up, that total could reach 10m pensioner taxpayers by the end of the decade."
"The one bit of good news is that most of these pensioners will not need to fill in a tax return," added Webb.
"Any tax due will usually be collected via a tax code on their private pensions or through the ‘simple assessment’ process which involves HMRC using information it already holds to work out a tax bill."
What's the reaction been?
Caroline Abrahams director of Age UK told Yahoo News that "as a matter of principle", the senior citizens charity would oppose any measures that "hit pensioners on low and modest incomes".
"A continued freezing of the personal allowance for income tax comes into that category," she said.
"With prices for essentials going up and up older people in this position are already struggling to make ends meet: they need more support, not less, and we hope the budget will include measures to help them with the cost of living, so no pensioner is left behind.
"We think that the personal allowance for income tax should be unfrozen for everyone since holding it where it is at a time when prices continue to rise, hurts those without a lot of money coming in of all ages.
"It makes little sense for the state to give older people money in the form of their pension with one hand, only to take some of it away with the other."
In a column for the Daily Express, Dennis Reed, director of senior citizens organisation Silver Voices warned the "consequences for the quality of life of senior citizens are enormous".
"The large majority of older people, up to 10 million, will have been brought into the tax system by 2030, meaning that every Triple Lock increase will immediately lose 20% of its value," he added.
"This agenda is being pushed hard in government by anti-pensioner individuals in the Treasury like Torsten Bell MP whose political mission seems to be to make pensioners pay for the current economic mess."
The Institute for Fiscal Studies (IFS) has commented earlier this month on the prospect of the full new state pension exceeding the personal allowance for tax for the first time in 2027/28.
"In 2022/23, just under half of those on the full new state pension were taxpayers," the economic research institute said.
"By 2027–28, that figure will be 100%. Unless the government grants an exemption, pensioners with low incomes will be required to begin paying tax directly to HMRC, creating an additional administrative burden for millions of people."
The IFS adds that many single pensioners who are in receipt only of the full state pension could become eligible for a small amount of pension credit, as their after-tax income will push them below the threshold for this benefit.
"Many other entitlements, including the free TV licence, are passported from pension
"It will also make future increases to the state pension less costly overall for the government and less beneficial to pensioners, since a larger fraction of state pension increases will be returned to the exchequer via higher tax."
What are income tax thresholds?
Income tax is split into four bands:
Personal allowance: 0% tax on earnings up to £12,570
Basic rate: 20% tax on earnings between £12,571 and £50,270
Higher rate: 40% tax on earnings between £50,271 and £125,140
Additional rate: 45% tax on earnings over £125,140
Your personal allowance goes down by £1 for every £2 that your adjusted net income is above £100,000. This means your allowance is zero if your income is £125,140 or above.
