Pensioners will pay ‘retirement tax’ in three years - or less

Most pensioners are set to be paying income tax within the next three years, it has been warned. Ahead of Rachel Reeves’ budget, experts feared she would extend the income tax threshold freeze beyond the 2028 end point instilled by the Conservative government.

This will essentially creating a stealth retirement tax as the rising state pension would eventually surpass the tax-free threshold of £12,570. While the Chancellor confirmed she intends to keep to this deadline, new forecasts have revealed that retirees likely have less than 3 years until the retirement tax hits regardless.

The Office for Budget Responsibility published estimates for the annual state pension rises throughout the next 5 years. According to this forecast, the full new state pension will surpass the tax free threshold by April 2027 at an annual rate of £12,592.

By 2029, the OBR expects the state pension to be hit £13,230 which will make retirees liable for an income tax bill worth over £100 a year if this is their only income. The forecast is also relatively conservative in how much it expects the state pension to rise each year.

The triple lock mechanism uplifts the state pension rates every April according to the highest between three figures: average earnings growth, inflation or 2.5%. This means the annual rises can fluctuate greatly as the rate was increased by 8.5% in 2024 in line with the increase in wages while next April will see a 4.1% rise.

For their forecast, the OBR used the minimum rises state pension will see from April 2026 until April 2029 at 2.5%. The reality of this means many retirees will have an income tax bill in less than 3 years while 2.5 million pensions are already paying this retirement tax according to consultancy LCP.

Income tax takes into account a number of different income streams include private or workplace pensions and rental income, meaning some retirees are already over the £12,570 threshold from their very first day of retirement. However, experts have warned that the freeze combined with rising state pension sums could see the most vulnerable retirees being taxed.

Alice Haine, personal finance analyst at Bestinvest by Evelyn Partners, is raising the alarm on this in particular. The expert told MoneyWeek: “Landing retirees with no other sources of income with tax demands will be unfair and extremely worrying for pensioners who are already struggling to get by after the cost-of-living crisis.”