Why is not there a particular allowance so pensioners on low incomes do not pay tax? STEVE WEBB replies

I’m confused over what is going on with the state pension and tax once it goes through the tax-free personal allowance.

There used to be an age-related personal allowance starting from the age of 65 which was higher than the standard personal allowance.

I think this increased personal allowance was then reduced back to the standard personal allowance if your overall income exceeded a set limit of income, is that correct?

To avoid those pensioners with low levels of overall income being subject to tax, why can’t we just have an age-related personal allowance increased to a reasonable sum just above the state pension?

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Steve Webb replies: You are quite correct to say that there used to be an extra tax allowance – an ‘age allowance’ – available to those aged 65 or over, and that this was clawed back from those on higher incomes. 

But in the 2012 Budget, George Osborne announced that this was being phased out and now most pensioners and people of working age both have the same allowances.

In terms of the current situation, the current tax free allowance is £12,570, and this will be frozen at least until 2031.

From April 2026 the new state pension will be £12,548 – just £22 below the tax threshold. 

And in April 2027, the ‘triple lock’ policy, which guarantees an increase of at least 2.5 per cent, means that the pension will definitely go above the tax threshold, to a minimum of £12,861.

If nothing is done, people who only have the new state pension will have a tax bill of just under £60 in 2027/28, rising to around £120 in 2028/29 and just over £180 in 2029/30.

In the Budget, the Chancellor said that people on the standard rate of the new state pension who have no other taxable income, and who would otherwise have a bill assessed through the ‘simple assessment’ process, will have this waived for the next three years.

There are all sort of reasons why this is a very strange idea.

First, it is unfair to the people on the old state pension who could have exactly the same state pension (from basic pension plus Serps) as someone on the new state pension but who will still be taxed. 

As an aside, I estimate that there are currently around 2.5million people on the old state pension who already have a state pension which – on its own – is in excess of the tax allowance, but no one seems to have thought that this is a problem.

Second, this tax ‘amnesty’ is not available to people who have even a small amount of private pension which seems entirely unfair.

Third, it seems odd to exempt a pensioner from tax if they are in this particular situation when an employee on exactly the same income (from wages) would pay both income tax and National Insurance contributions.

In terms of potential solutions, as you say, one option would be to (re)introduce a small age allowance, sufficient to make sure no-one pays tax on the new state pension on its own.

I’m afraid however that I don’t think that the Government will go down this route.

The reason for this is that nearly 9million people over state pension age are taxpayers. 

If an age allowance was introduced across the board, all 9million could benefit, at considerable cost to the Government. I’m afraid they will be looking at something cheaper and more targeted.

Given the situation we are in, and assuming that the Government is not going to budge on moving the tax threshold, I think there is probably a proposal which is relatively cheap but not quite as unfair as what is currently proposed.

My suggestion would be that the Government simply sets a ‘de minimis’ for small income tax bills, writing off such small amounts across the board.

For example, at present the ‘simple assessment’ process means His Majesty’s Revenue & Customs gathers all the information that it holds about a taxpayer and sends out an end-year tax bill if it is not possible to collect tax through a PAYE tax code.

In some cases, as with the new state pension in 2027, the result of this calculation will be a very small number.

My suggestion is that they simply write off these small sums for everyone.

As we are talking about small amounts and a very limited group of people, this would probably not cost the Government much money. But it would have the advantages that:

– It makes no distinction between those on the old or new pension

– It could be set at a level which did not penalise people for having very small amounts of private pension income

– It treats pensioners and workers the same.

This would be something of a ‘sticking plaster’ solution which would get the government through to the end of this Parliament. 

A new government could then reassess the relative levels of pensions and tax allowances and come up with a longer-term plan.