A combination of the continued freeze in income tax thresholds and increases in the state pension mean a large number of pensioners are being dragged into the tax net for the first time, according to analysis by LCP.
The firm found 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.
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.”
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.
However 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, HM Revenue & Customs will operate a system known as ‘simple assessment’, but pensioners may not be aware of this, and they are at risk of getting an unexpected tax demand, LCP explained.
Under ‘simple assessment’, the Department for Work and Pensions 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.
Following this, 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 January 31, the following year.
LCP said 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.
A Treasury spokesperson said: “Pensioners whose sole income is the new state pension do not pay any income tax, and this year we provided the biggest ever cash increase to pension payments, a 10.1 per cent rise.
“Our tax burden remains lower than any major European economy – and by raising personal thresholds over the past decade we have taken three million people out of paying tax altogether.
“The best tax cut we can provide right now is to halve inflation, which we’re on track to do this year as long as we stick to our plan.”
Webb said to give an idea of the figures involved, the income tax threshold has been frozen at £12,570 since 2021/22 which 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 2.3mn 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.
While 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 one in five 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,” the firm said.
“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.”
sonia.rach@ft.com
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