A combination of the continued freeze in income tax thresholds alongside big increases in the state pension means large numbers of pensioners are being dragged into the tax net for the first time.  But new analysis by LCP has shown that hundreds of thousands of these pensioners have no PAYE income (such as earnings or private pensions) which can be used to collect the tax which they owe.  As a result, these pensioners are set to get tax demands *the year after* they have received their pension and will need to set money aside now for when that tax demand arrives.

For pensioners who have a state pension and a private pension, the Government will collect any tax due through the ‘tax code’ applied to the private pension. But growing numbers of pensioners will be over the tax threshold based purely on a state pension, and there is no automatic way of collecting the tax that they owe, because state pensions are paid in full – before the deduction of tax.

In cases of this sort, HMRC will operate a system known as ‘simple assessment’, but pensioners may not be aware of this, and they are at risk of getting unexpected tax demands.

Under ‘simple assessment’, the DWP will notify HMRC at the end of a tax year how much state pension each individual has received.  If this takes the individual over the income tax threshold there will be a tax bill to be paid.  So HMRC will write to the pensioner *after the end of the tax year* telling them that they have not paid the tax due on their state pension and requiring them to make a payment before 31st January the following year.  This means that pensioners could have received – and spent – all of their pension during one financial year only to receive a tax bill on that pension the following year.

To give an idea of the figures involved, the income tax threshold has been frozen at £12,570 since 2021/22.   This means that anyone with a state pension over £242 per week would owe some income tax.   According to DWP’s online statistics, as at November 2020 over 2.3 million pensioners had a state pension of £195 per week or more, and taking account of state pension increases since then, these people would now have a pension over the tax threshold next year. 

Whilst some of these pensioners will have private pensions which can be used to collect any tax due, others will have large state pensions precisely because they did not make alternative private provision.  LCP estimates that around 1 in 5 of these pensioners, or more than 400,000 may have no other source of income from which HMRC can collect the tax owed. 

This is the group who are now at risk of getting unexpected tax bills.  They may need to consider setting aside some of their state pension each month so that they have the funds available to pay a future tax bill.

Because these new taxpayers have not previously had to fill in a tax return or had much dealings with HMRC, they may be surprised to receive a letter out of the blue demanding tax.  Indeed, one group specialising in the tax affairs of older people has had to issue a warning to people not to regard these letters as ‘scams’ and has explained how people can be sure they are genuine (see: https://www.litrg.org.uk/latest-news/news/230721-if-you-have-received-letter-hmrc-about-simple-assessment-tax-bill-–-don’t )

Commenting, Steve Webb, partner at LCP said:

"Millions of pensioners have been dragged into the tax net for the first time in recent years, primarily because of the multi-year freeze on tax thresholds.  Many are now at risk of an unexpected letter from HMRC asking for tax they may not have realised was due.  Any pensioner with a pension next year over £242 per week will have tax to pay, and if they do not have a private pension through which the tax can be collected, they may need to set some money aside for an unwelcome tax demand."

A Treasury spokesperson said:

“Our older population have the right to security and dignity in retirement which is why this year we provided the biggest ever cash increase to the state pension, a 10.1% rise, which comes on top of extra direct cash payments worth up to £1350 each to support with cost of living challenges and protection from rises in energy bills.

 “We have taken three million people out of paying tax altogether since 2010 through raising the Personal Allowance, and the Chancellor has said he wants to lower the tax burden further but sound money must come first.”