New income tax ‘waiver’ set to exclude anyone who delayed taking their state pension

People who put off taking the state pension and so get higher payments are among those set to be excluded from a new income tax ‘waiver’ for poorer pensioners.

The Government says it is committed to letting older people off paying income tax if their ‘only income is the full new or basic state pension without any increments’, but details are still pending.

The full rate state pension is expected to top £13,000 from next spring, busting the basic rate threshold of £12,570, which is frozen until 2031.

The Treasury’s promised countermeasure, of excusing those whose sole income is the state pension from paying income tax, will benefit just one in 18 pensioners, according to an industry study earlier this year.

Former Pensions Minister Steve Webb, a partner at LCP which did the research, says: ‘The uncertainty about the proposed “tax waiver” on state pensions makes it difficult for people deciding now whether or not to defer taking their state pension.’

A This is Money reader contacted us to say he believes he will be penalised in future compared with those who didn’t delay, because he already deferred in 2020-21 and so gets £11.48 a week extra state pension.

Many people put off taking their state pension, and some do so accidentally just by not claiming it at the time they qualify – if you do nothing, it will automatically be deferred.

Under current rules, you get an extra 5.8 per cent added to your state pension for each year you defer. 

People who reached state pension age before April 2016 get a more generous bump of 10.4 per cent, or can choose a lump sum plus interest instead.

Mr Webb, who is This is Money’s retirement expert, says: ‘As far as we can tell, anyone with increments on their state pension, including those for deferral, will miss out on the proposed tax waiver.

‘This could result in a loss of hundreds of pounds annually by the third year of the policy and makes deferring taking your state pension less attractive financially.

‘But people are being expected to make this decision right now, whilst they are still in the dark about how the proposed policy will work. This is one of many anomalies of what has been announced so far, and we urgently need clarity as to how these are going to be dealt with.’

Many people with any private work or personal pensions are already taxpayers, as are older state pensioners who earned sizeable Serps or S2P during their working lives, and they are among the many who will miss out on the ‘waiver’.

The plan could drive a wedge between pensioners who are exempt and those still expected to stump up tax, and get increasingly expensive – yet be hard to ditch.

LCP estimates that someone wholly dependent on the new state pension, currently £12,548 a year, would be let off around £88 income tax a year in 2027-28, £153 in 2028-29, and £220 in 2029-30.

Mr Webb says the following pensioners look set to be disqualified.

– Someone with just one pound of other taxable income, who could be disqualified for a waiver worth a few hundred pounds a year in a few years’ time.

– People on the old pre-2016 state pension plus Serps, receiving exactly the same as someone on the new state pension, who will not be exempt because Serps is an ‘increment’ to the basic pension.

– Those under state pension age who are on exactly the same income as someone over pension age who gets the waiver.

– Someone with no other taxable income, but with ‘increments’ such as for deferral of state pension.

I’m locked out of new income tax waiver

‘My situation is a concrete, live example of how current Treasury policy actively penalises savers who followed government guidelines to defer,’ says a This is Money reader, who preferred not to give his name.

‘I reached state pension age in 2020-21 and chose to defer my pension. I have no other source of taxable income.

‘My current four-weekly payment is £1,011.12 (£252.78 per week), giving me an annual pension of £13,144.56.

‘Because the baseline standard new state pension is £241.30 a week, my earned deferral increment is exactly £11.48 a week or £596.96 a year.’

He fears this will lock him out of the government’s proposed ‘sole income’ tax waiver, forcing him to pay tax on his entire pension above £12,570 in future.

He points out that his standard pension is increased every year according to the triple lock – whichever is highest of 2.5 per cent, wage growth or CPI inflation every year.

But while his standard pension rises in line with the triple lock, the extra payment he gets for deferring is increased according to the inflation figure.

‘A standard pensioner who did not defer will mathematically overtake me in net take-home cash in just a few short years,’ he tells us.

Looking ahead to how the state pension might increase next spring, the latest wage growth figure was 4.1 per cent, while the most recent inflation figure was 2.6 per cent.

The next average earnings growth number announced in September is therefore the one likely to decide the next state pension rise.

If it stays at 4.1 per cent the full rate new state pension for those retiring since 2016 could rise from the current £241.30 to £251.20, amounting to a £500 a year increase from April 2027.

People on the old basic state pension would see a rise from the current £184.90 a week to £192.50, or just shy of £400 a year.

What does the Government say?

‘Pensioners whose only income is the full new or basic state pension without any increments will not pay income tax and we are committed to that over this parliament,’ says a Treasury spokesman.

‘By keeping the triple lock, 12 million pensioners will see their income rise by up to £470 this year, and they continue to benefit from one of the most generous personal allowances in the G7.’