Stealth tax to ensnare millions of pensioners

• Prospect due to wider stealth raid to raise up to £75bn a year from 2027-28 
• This is the equivalent of an extra 9p in the pound on income tax
• Full state pension set to rise above threshold for income tax for first time

Millions of people who rely on a full state pension to fund their retirement face being dragged into the tax net in the coming years, The Mail on Sunday can reveal.

The alarming prospect is due to a wider stealth raid estimated to raise up to £75 billion a year from 2027-28 – the equivalent of an extra 9p in the pound on income tax.

As a consequence, the full state pension is set to rise above the threshold for income tax for the first time since it was introduced more than a century ago.

It comes after Chancellor Jeremy Hunt imposed a punishing six-year freeze on tax allowances and thresholds.

Former Pensions Minister Steve Webb, now at consultancy LCP, said: ‘In the past, very few people who lived off a state pension in retirement had to think about tax, but now millions are being dragged into the tax net because of the freezing of personal allowances.’

He said some of those affected are ‘by no means well off and some may even be receiving means-tested benefits’.

The stealth freeze also means that millions of lower earners will soon have to start paying income tax because their personal allowance – the level at which workers begin to pay tax – is stuck at £12,570.

The state pension is paid to 12 million men and women aged 66 and over and is currently worth up to £10,600 a year.

It is protected under the triple lock system, which means it will increase by the rate of inflation, annual earnings growth or 2.5 per cent – whichever is the highest.

The state pension, which is given to those who have paid national insurance contributions for 35 years, is set to rise by 8.5 per cent to £11,501 next year in line with the latest rise in earnings.

Even if pay rises are capped at 5 per cent in each of the following two years, the full state pension will exceed the personal allowance by 2026/27 – pulling people with no other income into the tax net for the first time.

This will mean the number of people of state pension age who pay income tax will soar from 8.1 million in 2023/24 to 10.5 million in 2026/27, according to wealth manager Evelyn Partners. That compares with just 6.5 million tax-paying pensioners in 2020/21.

The vast majority of pensioners who pay tax do so at the basic rate of 20p in the pound. In many cases, the amount due will be moderate at first, but retirees also face the bother of having to deal with the taxman.

Webb added: ‘It is time that tax thresholds were reviewed so that those on modest incomes are no longer caught up by the tax system.

‘Retirement should be a time for enjoying yourself, not having the hassle of having to deal with HM Revenue & Customs.’

Forecasts prepared for the Growth Commission by the Centre for Economic and Business Research show the state pension will be taxable in 2027/28 – the last year of the freeze.

Growth Commission co-chairman Doug McWilliams said: ‘Our assumption is that average earnings will drive pensions since they are forecast to rise faster than inflation or 2.5 per cent.’ The commission was set up by former Prime Minister Liz Truss, but works independently of her.

Hunt’s huge stealth tax grab acts as a drag on the economy as it leaves households with less money to spend.

The Bank of England will weigh up the growing impact of stealth taxes on the wider economy when it decides on Thursday whether to change the base rate, currently at 5.25 per cent.

Experts say the outcome hangs in the balance after the Bank recently paused 14 consecutive interest rate rises.

The scale of the stealth tax raid has ballooned because of inflation coupled with Hunt’s decision to extend the freeze for two years until 2027/28.

The Mail on Sunday first highlighted the tax raid in February 2022 when the CEBR predicted that it might raise £40 billion.

Hunt is coming under pressure to tamper with the pension triple lock to save money. Maintaining the triple lock could add as much as £45 billion a year to the welfare bill by 2050, the Institute of Fiscal Studies said recently.

It warned that would put ‘insurmountable pressure’ on the Government to increase the minimum retirement age.