Millions face paying again a few of their state pension to HMRC in a stealth tax raid. Here, our cash specialists clarify what you’ll want to know… and what do to about it

Millions of retirees whose only income is the state pension will soon be forced to hand money back to the taxman as part of a stealth tax raid.

A bizarre tax cliff edge will mean those who receive the full state pension will be taxed on that income – and low-income pensioners will be dragged into the tax system for the first time.

But why is this happening and will a tax bill land on your doorstep?

Do I need to pay tax on my pension?

Like those of working age, pensioners need to pay tax on their income, too.

Income may be a private pension, wages if still working, some state benefits and, of course, the state pension.

Everyone has a personal allowance of £12,570 every year, which they can earn without paying any income tax.

There are a few exceptions to this tax-free amount. For example, those who are blind can get an extra £30,70 a year tax free, which can be transferred to a spouse or civil partner, while those who earn more than £100,000 will have their tax-free amount be tapered away.

If pensioners earn above this amount, their income is subject to the same tax rates as workers and they must hand over money to HM Revenue and Customs.

For example, basic rate taxpayers must pay 20 per cent in tax on earnings over their tax-free personal allowance – up to £50,270.

Higher rate taxpayers lose 40 per cent of their income between £50,271 and £125,140 to the taxman. Additional rate taxpayers need to pay 45 per cent on earnings more than £125,140 – and they do not have a personal tax-free allowance of £12,571.

If you rely on just the state pension it is unlikely you will need to pay any tax as the full, new state pension is currently just over £11,502 a year, set to rise to £11,973 a year in just a matter of days.

Some people with legacy state pensions will receive a state pension that is greater than the £12,570 allowance, in which case they will have to pay tax on the portion that exceeds their allowance.

But for the most part, those who just receive only the state pension will be able to enjoy their money without paying a penny in tax.

However, official forecasts have revealed these low-income vulnerable retirees will soon be handed a tax bill as part of a stealth tax raid.

Why is this happening?

Most personal tax thresholds have been frozen since 2021 and will remain so until April 2028 as the Treasury looks to fill its coffers.

As incomes rise but thresholds stay still, more people are dragged into higher tax bands – or even forced to stump up income tax for the very first time. This is a process known as fiscal drag.

The state pension rises every April to protect the income of pensioners. The increase is decided based on something called the ‘triple lock’ mechanism.

This means each April the state pension increases by the highest of either 2.5 per cent, September’s inflation number or earnings growth figures for the May to July period.

But this is now pushing those who rely only on the state pension within touching distance of £12,570, the amount at which income tax starts to be levied at 20 per cent.

Jon Greer, head of retirement policy at Quilter, said: ‘What was intended as a mechanism to protect pensioners from poverty is now colliding with fiscal drag.

‘This situation is the result of the triple lock producing some significant increases in the state pension due to high inflation and earning figures while the Government has failed to uprate tax thresholds in tandem.’

Chancellor Rachel Reeves said in the Autumn Budget that income tax thresholds would rise in line with inflation from 2028 but stopped short of unblocking the freeze in this tax year.

The Government ‘s election manifesto promised not to raise rates of National Insurance, income tax or VAT for working people. But by keeping the thresholds frozen until at least 2028 the Treasury can still increase its tax take.

It’s a sneaky stealth tax used by policy makers to rake in more money without increasing the headline rate of income tax, which one analyst dubs ‘surreptitious’.

When will I need to start paying tax?

State pension payments will breach the personal allowance in 2027, according to official Office for Budget Responsibility (OBR) forecasts released alongside this week’s Spring Statement.

It predicts the state pension will soar by 4.6 per cent next April, which will bring the state pension to £12,569.85, just 15 pence short of the personal allowance, according to analysis from Quilter.

The state pension amount is determined on a weekly basis but paid every four weeks in practice. Quilter has worked out the state pension payments based on 365.25 days, to account for a leap year, which means these calculations may differ to other analyses.

This figure means that retirees on the full, new state pension who draw an income of more than 15 pence a year from a personal pension will be dragged into the tax net.

However, in April 2027 the OBR says the state pension is likely to rise by 2.5 per cent. This means payments will tot up to £12,885.50 annually, some £315.50 over the personal allowance, Quilter said.

This means everyone who receives the full, new state pension will be handed a bill for just over £63 – even if there don’t receive any other income.

But other analysis shows retirees who rely only on the state pension may get a tax bill as soon as next year.

Annual state pension payments could soar by 5.5 per cent to £12,631 in April 2026, according to Deutsche Bank forecasts.

This potential hike would mean low-earning retirees who only receive the full, new state pension would be forced to pay the basic 20 per cent rate of tax on income above £12,570.

This would mean the vulnerable pensioners would have a taxable income of £61, which would land them with a bill of just over £12 if they have no other income stream.

How will the tax be collected?

The Government typically collects tax through the tax code applied to a private pension as it is classed as PAYE income.

This means that as your state pension increases, you may begin to receive a little less from your workplace or private pension. This is because HMRC will never deduct tax from your state pension, so any tax due would be levied on your personal pension via the PAYE system.

In this case, you may not need to do anything as your taxes should automatically be adjusted.

For those who do not have a personal pension and only rely on the state pension, the tax cannot be easily collected.

In these cases, HMRC will use a system known as ‘simple assessment’, where bills are issued after the end of the tax year.

The taxman should send you a letter with the exact amount of money you need to pay and bank details for you to make the payment, said Sir Steve Webb, a former pensions minister and now partner at consultancy Lane Clark and Peacock.

Mr Webb said if the bill is matter of pounds HM Revenue & Customs may not decide to pursue the due tax for the first year.

‘But the following years the bill will be more because the tax thresholds have been frozen. Pensioners may well have spent the money because the bill isn’t known until after the tax year so people will have to set aside a bit of their pension.’

Many will receive their tax bill the year after they have received their pension, and so will be responsible for setting aside money each time they receive their state pension.

For example, if your income becomes liable to tax for the first time in the 2024-25 tax year, you will not receive a letter from HMRC until Summer or Autumn in 2025.

You must make the payment by January 31 following the end of the tax year, or within three months of the simple assessment.

Payment must either be made online via your personal tax account, by making a bank transfer or by sending a cheque.

HMRC bases the calculation for the simple assessment on information gathered from the Department for Work and Pensions, employers and other organisations (such as banks and pension companies). It is important to check the figures on the simple assessment calculation carefully, according to consultancy the Low Incomes Tax Reform Group.

You can challenge the amount of tax due within 60 days of receiving the simple assessment.

If you have more complicated tax affairs, you may have to file a self-assessment tax return, according to Robert Salter, of accountancy firm Blick Rothenberg. In this case, HMRC will write to you with a letter notifying you of this and you will have to fill in the same forms as a self-employed worker.

What if I can’t afford to pay the tax?

As there is a one-year delay between when pensioners receive their state pension and when the tax bill is due, there is a risk that many will get caught out by surprise tax bills.

You may be able to set up a payment plan with HMRC if you are unable to pay the tax in one go. If you have an outstanding payment, or are worried you might miss a future payment, you can call the HMRC Time to Pay helpline on 0300 200 3822 or create an arrangement using your online Government Gateway account.

Mr Webb says HMRC is likely to ask for a breakdown in your budget to see how tight money is.

‘They are unlikely to set up an arrangement if they see you’ve been on foreign holidays, for example,’ he says.

What can I do to lower the tax bill?

Unfortunately, there’s very little you can do to reduce the tax bill if your only income is the state pension.

But you could consider deferring the state pension if you are still working as the payments could add to your taxable income, says Rob Morgan, of wealth manager Charles Stanley.

This means you’ll get a higher payout later as every nine weeks you defer boosts your state pension by 1 per cent. But be careful as this could also be subject to tax or tip you into a higher tax band later down the line as the additional amount is paid alongside the standard state pension.

Plus, if you have a total taxable income below £17,570 this tax year there is a ‘starting rate’ for savings. This means you will not have to pay tax on savings interest up to £5,000.

But this £5,000 allowance is tapered away by £1 for every £1 of income above your personal allowance.

Typically, a basic rate taxpayer will only have a tax-free allowance of £1,000 on savings interest.

Use your annual £20,000 individual savings account (Isa) allowance if you can as this means you can later take money from them tax-free, whether that’s in savings interest, dividends or capital gains.

Winnings from National Savings and Investment’ Premium Bonds are also tax-free.