State pension tax warning for half a million retirees as big bills could hit next year

Worried senior couple checking the bills at home

HALF a million retirees could be slapped with a tax bill next year because of rising payments.

The state pension could be worth over £200 a week in 2023 if inflation stays high.

More pensioners could be hit with tax bills next year

While the higher payments will help in the cost of living crisis, it could push hundreds of thousands more people into paying tax.

Former pension minister Sir Steve Webb, who is now a partner at pensions specialists LCP (Lane Clark & Peacock), said frozen income tax thresholds, combined with pension increases next year, could lead to fresh tax bills for pensioners.

LCP looked at HM Revenue and Customs (HMRC) figures to make the estimates.

It said that in April 2022 the state pension rose by only 3.1%, yet as income tax thresholds were frozen the number of over-65s paying tax rose by 390,000 between the financial years 2021-22 and 2022-23.

With a much larger pension increase expected in April 2023, a bigger jump in the number of over-65s paying tax is expected.

The current maximum new state pension is £185.15 a week. The amount rises annually in April based on the previous September’s inflation figure.

Inflation is currently 9.9%, and if it stays at that, the state pension would rise to £203.47 a week.

But inflation could go higher and that means the amount could be more.

LCP calculations suggest this is likely to see at least half a million more being added to the total, based on the current rate of inflation.

LCP said that many work pensions, separate to the state pension, will be increased because of inflation too, although the exact rules will depend on the type of pension you have.

“Stealth tax rise”

Sir Steve said: “Freezing tax thresholds is a stealthy way of raising tax at the best of times, but at a time of soaring inflation, freezing thresholds has a profound effect.

“During this Parliament we have already seen over a million extra pensioners dragged into the tax net, and next April’s increase is likely to add at least half a million more.

“If the Chancellor is looking for ways to cut taxes and ease cost of living pressures on those on modest incomes, he could do worse than review the long-term freeze of income tax allowances.”

The income tax rates were frozen by ex-Chancellor Rishi Sunak in his 2021 Budget, and for a period of fours years from this tax year to 2025-26.

But as incomes rise over time it means that more people are drawn into paying tax or higher tax bands.

A Treasury spokesperson said: “Over the last decade we have increased the personal allowance people have before they pay any income tax from £6,475 in 2010 to £12,570 today.

“This has lifted millions of the poorest out of paying any income tax at all, and meant a real-terms tax cut of £750 for 27 million people.

“The vast majority of taxpayers will still pay the basic rate and the UK still has the highest personal allowance in the G20.”

How is my pension taxed?

When taking your pension it can be taxed in different ways, according to how you get the cash and the type of pension.

But you won’t pay National Insurance contributions like you do on a salary from a job.

State pension is taxable but it’s paid without tax deducted.

Since the so-called pension freedom changes took force in April 2015, workers have been able to take 25% of their work or personal pension as a tax-free lump sum.

Anything after this is usually taxed at the normal rate.

That means you’ll usually get a certain amount tax-free each year known as the personal allowance, according to Moneyhelper.

That’s currently set at £12,570 a year. so anything less than this and you won’t pay any tax at all.

This might be higher or lower if you get a tax break though.

After this you’ll pay tax at the usual rates: 20% on income over £12,570 and up to £50,270 40% on any income

If you get the maximum amount of new state pension, it is £9,627.80 a year currently, which is less than the tax-free personal allowance.

That could rise to around £10,580.44 based in current inflation – around £952 closer to the threshold for paying tax.

But if you have any pension income from a work or personal pension then your income could be more than this and be taxable.

Usually your pension provider calculates the tax and pays it on your behalf to HMRC.

Unfortunately, there’s little you can do if your income becomes taxable due to increased payments.

Sir Steve told HOAR the pensioners should be aware of the change and how they could be affected, even with a modest work pension.

Meanwhile, thousands of retirees could be due a payout worth over £4,700, pension expert Romi Savova explains – here’s how you could get it back.

Ans some health conditions mean many on state pension could get extra cash on top to help.