Tax and the state pension – an explainer

This explainer is part of a series produced by CIOT for the 2024 general election

Is the state pension subject to tax?

Yes. Generally speaking, all pension income – state and private – is subject to income tax (though not to national insurance). (Exceptions are set out in the additional information section – see ‘What pension income is not taxable?’)

Are the Conservatives proposing to change this?

No.

So what are they proposing?

They are proposing to increase the income tax personal allowance (the amount of income you can receive tax free) just for those who have reached state pension age so that it stays ahead of the standard new state pension entitlement.

What does this mean in practice?

The personal allowance has been frozen at £12,570 a year since 2021-22 and current government policy is to keep it frozen at this level up to and including the 2027-28 tax year. The Conservatives are proposing to unfreeze the personal allowance from April 2025 just for those who have reached state pension age, increasing it in line with the state pension in each year of the next Parliament. So if, for example, the standard new state pension goes up by an annual total of £500, the tax-free personal allowance would also go up by £500. Unless there is a change in government policy, for those below state pension age the personal allowance will remain frozen until at least April 2028.

How significant is this?

It depends how fast the state pension increases. Under the ‘triple lock’ the state pension rises each year by the higher of wages, prices (i.e. inflation) or 2.5 per cent. Next year the highest of these is likely to be wages, which are currently rising at 6 per cent annually (though many economists expect this to fall a bit over the coming months).

The Conservative Party has published figures, using Office for Budget Responsibility projections, which project (based on estimates of future wages and inflation) that the new pensioner additional personal allowance would, under the party’s proposals, be £1,140 by 2027-28. That would save a pensioner able to use it in full 20 per cent of that amount: £228 over the course of the year.

Will it affect all pensioners in the same way?

No. Some pensioners are already paying income tax and some are very unlikely to ever pay income tax even if their personal allowance stayed the same.

Broadly it’s helpful to think of pensioners as falling into three groups.

First, those who already pay some income tax because they have additional sources of income on top of their state pension (or in some cases a high enough state pension to push them over the personal allowance on its own).More than half of those above pension age (62 per cent in 2022-23) fall into this category. These pensioners will be able to make immediate use of the increased personal allowance (gaining up to £228, as set out above), assuming there is no tapering introduced for those with income over a certain level (as was the case when we had age related allowances before). If there is no tapering (or if it is only tapered alongside the usual personal allowance restriction for those with incomes over £100,000), then it is possible that a tax saving of 40 per cent would be achieved on the additional allowance awarded for pensioners paying higher rate income tax.

Second, those who receive the full new state pension and don’t have additional income. This group would benefit under this policy as fiscal drag would no longer gradually draw them into the income tax net. They will only start to benefit from the increased personal allowance when their state pension rises above the standard personal allowance (£12,570). The full new state pension is projected to rise to £12,578 by 2028, so without any additional age related personal allowance, these state pensioners would be projected to face a total income tax liability of £1.60 in that year.

Third, those entitled to a lower rate of state pension than the second group and with no (or very little) other income. For this group the benefit of an increased personal allowance will be even less than for the second group and could well be non-existent.

Is this a tax cut or just reversal (for some) of a tax increase (freezing the personal allowance)?

In practice it will be a tax cut for those who benefit, even compared to how they would have fared if the personal allowance had continued to increase in line with inflation, as was the default practice prior to 2021-22. This is because the proposed additional allowance will increase in line with the standard new state pension, which will increase in line with the largest of wages, inflation or 2.5 per cent.

One consequence of this is, even if the government were to resume the practice of increasing the personal allowance in line with inflation from 2028-29 onwards, if inflation is below either wage growth or 2.5 per cent the pensioner additional personal allowance would continue to increase.

How significant is the state pension crossing the income tax threshold?

Fairly significant. While the amounts of tax due are, initially at least, fairly small, the administration involved, for both HMRC and the pensioners concerned, can be substantial, especially if the pensioner has no separate private or occupational pension, employment or other income that they would otherwise need to pay tax on – either under Pay As You Earn, or under the self assessment system.

If a pensioner has a sufficiently large private/occupational pension or employment income any tax due on the proportion of the state pension that exceeds the personal allowance will be collected directly from that private/occupational pension or other employment income via their Pay As You Earn tax code, using what is known as a ‘K’ code.

Where the pensioner either has no separate private/occupational pension or employment income or only a very small one/ones then the tax due on the proportion of the state pension over the personal allowance is, currently, usually collected either via HMRC issuing a simple assessment or the pensioner completing a self assessment tax return. In either case, the pensioner pays the tax direct to HMRC rather than it being deducted at source. It is currently not possible for tax to be deducted from the state pension itself.

Would it be simpler to increase the personal allowance for everybody?

Yes, though it would cost a lot more. A £500 increase in the personal allowance for everyone next year would cost the government £4.3 billion according to the government’s own ready reckoner.

There used to be separate age-related allowances for pensioners until the coalition government phased them out, freezing them from 2012-13 until the working-age personal allowance caught up with them. That was considered a simplification so arguably this change could be considered a complication to the tax system.  However, by ensuring that most people’s state pension is covered by their personal allowance, the need for alternative tax collection via a ‘simple assessment’ tax calculation after the year end, or a full self assessment tax return, is reduced. This undoubtedly constitutes a tax simplification for state pensioners and will likely be a lesser administrative burden for HMRC too, both in terms of assessing and collecting relatively small amounts of income tax.

Additional Background

Who qualifies for state pension?

The state pension can be claimed when an individual reaches the “state pension age”. The state pension age is currently 66. From 6 May 2026, the state pension age will increase to 67 by 6 March 2028.

To qualify for a state pension you must have fulfilled certain National Insurance contribution conditions over your working-aged life.

The amount you receive is not affected by your other income or capital (it is not ‘means tested’).

The date you reach (or reached) state pension age will dictate whether you receive the ‘basic state pension’ or the ‘new state pension’ (as below).

Basic state pension and the new state pension – what is the difference?

There are two different state pensions payable in the UK:

• The basic state pension is paid to anyone who reached state pension age before 6 April 2016.
• The new state pension is paid to anyone who reached state pension age on or after 6 April 2016.

Both are treated the same way for income tax purposes.

As of May 2023 there were about 12.7m state pension claimants, of whom 3.4m receive the new state pension.

Data from 2022 found that while roughly half of recipients of the new state pension received it in full (or more), around three quarters of the larger number of basic state pension recipients receive that in full (or more). Below we set out why some people might receive more or less than the standard rate of both new and basic state pension.

How much is the standard state pension?

The state pension went up by 8.5% in April 2024. The standard weekly rates are now as follows:

• Basic state pension (for those who reached state pension age before 6 April 2016): £169.50 a week from April 2024, or just over £8,800 for the whole year. 
• New state pension (for those who reached state pension age on or after 6 April 2016): £221.20 a week from April 2024, or just over £11,500 for the whole year.

The proposed increase to the personal allowance is in reference to the rate of the new state pension only, although all state pensioners would receive the same amount of additional personal allowance.

This means that the effect for those on the basic state pension would be different to those who receive the standard rate of the new state pension.

Why do some pensioners receive more than the standard rate of basic and new state pension?

Basic state pensioners may also be entitled to the ‘additional state pension’. This rate is variable depending on the circumstances of the individual; as a result, some will have an entitlement that exceeds the standard weekly amount cited above.

Some people receiving the new state pension might also receive additional payments due to having ‘protected rights’ on the transition between the ‘basic’ and ‘new’ state pension regimes so, again, their entitlement might exceed the standard weekly rate cited above.

For both basic state pension and new state pension, it is possible to ‘defer’ claiming. This can result in you receiving a higher weekly state pension award when you eventually decide to claim. See ‘How do I get state pension?’ below.

Why do some pensioners receive less than the standard rate of basic and new state pension?

As mentioned above, to qualify for a state pension you must fulfil certain National Insurance contribution conditions.

To claim the full standard new state pension you generally must have paid or been credited with 35 full years of NI contributions. If you have between 10 and 34 years of NI contributions you might receive a proportionately lower amount. If you have less than 10 years contributions, you are not entitled to a state pension at all.

The qualifying years required for the basic state pension (claimed by those who reached state pension before 6 April 2016) were different.

How do I get the state pension?

You must claim the state pension. It is not paid to you automatically (unless you already receive pension credit as part of a couple).

Most people will get a letter no later than two months before reaching state pension age telling them what to do to claim their state pension. You can submit a claim up to four months in advance. If you claim after reaching state pension age you can backdate the claim by up to 12 months (although not back before the date you reached state pension age). If you put-off or ‘defer’ claiming the state pension you may receive a higher pension amount when you do claim it later on.

 What pension income is not taxable?

The standard basic and new state pensions are subject to income tax, as are private and occupational pensions and any additional state pension or protected payments you are entitled to.

However some pension and pension-related income is usually tax free, including:

• Pension commencement lump sums up to 25 per cent of the capital value
• Child dependency additions paid with state pension or other social security pensions
• Christmas State Pension Bonus
• Cold Weather payments
• Winter Fuel payment
• Pensions Credit
• Industrial Injuries Disablement Pension
• War Pension

State benefits such as attendance allowance and incapacity benefit are also tax free.

For more detail on what pension income is taxable and what is not see:  What pension income is tax-free? | Low Incomes Tax Reform Group (litrg.org.uk)

Where can I get more help with tax on my state pension?

if you need more information about how your state pension is taxed, there some useful sources of information available online:

The CIOT’s Low Incomes Tax Reform Group: https://www.litrg.org.uk/pensions/state-pension/tax-state-pension

GOV.UK: https://www.gov.uk/tax-on-pension

MoneyHelper: https://www.moneyhelper.org.uk/en/pensions-and-retirement/tax-and-pensions/how-is-my-state-pension-taxed  

This explainer was written by:
Matthew Brown, Technical Officer, Chartered Institute of Taxation
Antonia Stokes, Technical Officer, Low Incomes Tax Reform Group
George Crozier, Head of External Relations, Chartered Institute of Taxation