In a move that could see a significant shift in the financial landscape for retirees, millions of state pensioners in the UK might soon find themselves paying income tax due to a proposed substantial increase in the state pension, the Express reports.

The Triple Lock’s Triple Impact

The government’s ongoing commitment to the “triple lock” promise is central to this potential change. The triple lock ensures that state pensions rise in line with the highest of three figures: inflation, average earnings growth, or 2.5 percent. However, with recent data indicating an 8.5 percent surge in total earnings growth, state pensioners could see their income from pensions rise to £221.20 a week, or £11,502 annually, if the government applies the policy fully.

This substantial increase, while seemingly beneficial, comes with a catch. It would push the incomes of many pensioners just over the threshold for income tax liability, thanks to the static personal income tax allowance, which remains at £12,570.

Taxing Times for Pensioners

What does this mean in practical terms? Essentially, pensioners who receive the full new state pension will have a mere £1,068 of their personal income tax allowance left untouched. This narrow margin means that even small additional incomes from a workplace pension or other savings – the “nest eggs” many retirees rely on – could tip them into the income tax bracket.

Gary Smith, a financial planning partner at Evelyn Partners, highlights the gravity of the situation: “Even a modest amount of additional private income will now turn a massive number of state pension recipients into income tax payers in 2024/25.” This comes on top of an already noticeable increase in the number of pensioners paying income tax this year.

In fact, HM Revenue & Customs data show that following this year’s 10.1 percent increase in the state pension, an additional 800,000 pensioners are already paying income tax, bringing the total to 8.5 million people aged 65 or over. This number is not just a record high; it’s also a 10 percent leap from the previous year.

The Cost of Retirement

The financial ramifications extend beyond just the number of people affected. Smith explains that even for those with defined contribution pension pots, the tax they end up paying will vary based on how they use their savings. Cashing in a pot in full could lead to a higher tax; conversely, opting for a lifetime pension annuity that pays £1,068 a year would require a fund of roughly £16,875.

However, retirees wishing to leverage the 25 percent tax-free lump sum option would need a total pot of £22,500 to cover both this and the annuity. With the Office for National Statistics noting the average pension wealth sitting at £37,600, these potential tax liabilities present a significant consideration for retirees planning their financial futures.

Looking Ahead: Financial Security in Retirement

The implications of this potential policy are clear: retirees will need to factor in not just the rising cost of living and the returns from any savings or investments, but also their increasing likelihood of being liable for income tax. All this despite tax rates themselves not increasing.