Potential increase in state pension to £12,600 next year, affecting numerous individuals and moving them into the tax-paying category.
State Pension Taxation Puzzle: RisingState Benefit, Frozen Tax-free Allowance
Retirees in the UK face an increased likelihood of having to pay income tax on their state pension, as the state benefit continues to grow while the tax-free allowance remains stagnant.
The government-mandated "triple lock" ensures the state pension increases each year, by the highest of inflation, wage growth, or 2.5%. Such a sharp growth has driven up the New State Pension to an estimated £11,973 per year in 2025/26.
Meanwhile, the tax-free Personal Allowance for income tax has been frozen since 2021/22, with no official plans to increase it. As a consequence, the gap between pension income and the tax-free threshold is gradually shrinking, potentially causing tax issues for retirees.
Those with additional sources of income, like workplace pensions, private pensions, or savings interest, might find themselves pushed over the Personal Allowance threshold even quicker. Notably, the number of pensioners paying higher and additional rates of tax has skyrocketed, with over one million now paying at the 40% rate or above – double the figure from four years prior.
The government maintains its stance on keeping income tax thresholds frozen until at least 2028. This policy, geared towards fiscal responsibility, will inevitably lead more pensioners to pay tax on larger portions of their income as both state pensions and other pensions grow.
The planned rise in the State Pension age (from 66 to 67 between 2026 and 2028) is not expected to slow the trend of tax-paying retirees. State pension recipients who are over the qualifying age and see their incomes rise in line with the increasing state pension amounts will still fall victim to the tax effect.
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- As the state pension continues to rise, retirees may find themselves paying income tax on their state pension, a trend amplified by the frozen tax-free allowance in personal finance.
- To mitigate this tax issue, individuals should consider diversifying their income sources, such as property, private pensions, or savings, while keeping an eye on their total income, ensuring it remains below the Personal Allowance limit to avoid higher tax rates.
