A state pension tax concession may not be available to the "vast majority" of retirees

According to research, only one in eighteen retirees will profit from the government's proposed income tax breaks

According to new research, the "vast majority" of retirees will not benefit from the government's plans for an income tax exemption starting next year.

Chancellor Rachel Reeves stated in the 2025 Budget that pensioners whose only source of income is the basic or new state pension would not be required to pay "small amounts" of tax through simple assessment if the state pension surpasses the tax-free personal allowance starting in 2027-2028.

The government has since clarified that pensioners in this situation won't have to pay income tax at all starting in 2027-2028 if their pension exceeds the personal allowance, despite the fact that it was initially positioned as reducing the "administrative burden."

Problems with BFIA today. It coincided with the chancellor's announcement that the allowance would remain at 12,570 until at least April 2031. The last time the threshold was raised was in April 2021.

The goal of this proposed waiver is to prevent pensioners who are only dependent on the state pensionthat is, who do not have any other taxable income or pension increasesfrom being required to pay taxes on the payment.

According to former pensions minister Sir Steve Webb, a partner at pensions consultancy LCP, only about 5.5 million pensioners, or one in 18, will be qualified for the concessions.

Given high inflation, wage growth, and the triple lock, the government anticipates that starting in April of next year, the rate will rise above the threshold for the first time. The full new state pension of 12,548 is currently only 22 below the tax threshold.

In contrast, the old state pension is significantly less than the threshold, and even with anticipated increases, it appears likely to stay that way. As a result, individuals who only receive the old state pension would not be required to pay income tax.

What impact will the government's proposals have on various pensioner groups?

Webb has referred to the differences in treatment between pensioner groups under the proposed scheme as "bizarre" because LCP's research shows how few people will truly profit from the change.

Anyone who reached pension age prior to 2016, when the flat-rate, single-tier system replaced the two-tier system of basic plus additional state pension (SERPS or S2P), will not be eligible for benefits, according to the company's most recent report, The tax treatment of state pensioners.

None of the 8.1 million pensioners in the previous state pension system will be eligible for the exemption, according to LCP's current data for 2025-2026. This is either because they only receive the old state pension, which at 9,614 annually is already below the income tax threshold, or because, in the case of 6.5 million of them, they also receive an additional state pension (either under SERPS or state second pension), which results in a pension "increment" on top of the basic payment.

In a similar vein, the majority of the five million recipients of the new state pensionthose who reach retirement age after 2016may also be left out.

According to the firm's calculations, 290,000 people are not based in the UK; one million receive protected payments or pension increases; 1.1 million have a new state pension rate that will stay below the income tax threshold for the next three years; and 1.8 million have other taxable income, such as investment income or private pensions, so they are not entirely dependent on the state.

LCP estimated the tax levels due over the remaining tax years (under this Parliament) using the Office for Budget Responsibility (OBR) outlook, assuming that the state pension will increase by 3.7 percent in April 2027 and then by at least 2.5 percent in April 2028 and 2029.

According to Webb, there are some possible "cliff edges" in the outlook that could put people with even one additional source of income in a very different tax situation than those without.

"Those who qualify for this tax break in 2027/28 do not have to pay taxes, but those who simply miss out due to one other source of income will have to pay income tax not only on the one but also on the income tax on their state pension a further 88," he stated. This cliff edge will rise over time, reaching 220 in 2029/30 from 153 in 2028/29. A "

The following table illustrates the amount of income tax that a person who is entirely dependent on the new state pension would have to pay in the absence of the proposed concession.

Source: The OBR's March 2026 Economic and Fiscal Outlook for April 2027-2028 is the basis for LCP's calculations, which then assume a minimum increase of 2.5 percent.

Webb uses the example of a person who has a small pension fund under auto-enrollment and cashes it out when they retire. As a result, they receive some taxable income and are no longer considered to be totally dependent on the state.

In an interview with BFIA, he stated that the government's mention of the previous basic state pension might be interpreted as a fair benefit, but it was actually more of a red herring.

"It is manageable to freeze tax thresholds for a year or two," he stated. By making a structural change to the tax system in a way that is not fully considered, freezing them for almost ten years has more unintended consequences.

Rather, a thorough analysis of the system is required to determine why tax thresholds exist in the first place, whether pensioners should pay the same rates as working people, and other issues. A "

What other options are there for the new tax break for pensioners who only receive the state pension?

He expressed gratitude that this is being offered as a temporary solution to the current Parliament's termination and offered two potentially more environmentally friendly options.

A general increase in the tax allowance for all pensioners is one option, though it is more costly than the current proposal.

"But this would come at a considerable cost because it would also benefit the eight million or more pensioners who are already paying taxes," Webb continued. This would not be a focused approach to the issue. The "

Additionally, he recommended that all small tax bills for pensioners be written off, which would be a more affordable and focused solution for the most vulnerable group. Additionally, it wouldn't distinguish between people using the new and old tax systems.

However, it would still only be a short-term solution, and any future government would still have to deal with the mounting expense of such a measure. A "

Webb continued, "The government already has a line at which it writes off small tax bills; it's just less well-documented."

"I'm fairly certain that self-assessment demand letters for amounts of four are not sent out by HMRC. We know they already have a line; all I'm asking is to make it larger. It's taxpayer money, so why shouldn't it be paid? The "

Additionally, LCP cautions that since write-offs increase in cost over time, the policy may cause issues for the following administration.

Webb stated: "It appears that the pensioners who receive benefits will have more than £200 in income tax written off annually by 2029/30. Similar to the triple lock, if the policy is carried over into the next Parliament, it will become more and more costly with each year that goes by. The "

"Pensioners whose only income is the basic or new state pension, without any increments, will not have to pay income tax over this Parliament," an HM Treasury representative stated.
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