State pension: HMRC tax on UK pensions explained - and state pension increases 2023 to 2024

Unexpected tax payments may require some pensioners to start setting money aside in the event they receive a surprise bill, a consulting firm has warned. More pensioners may be forced into paying taxes as a result of frozen income tax thresholds and bumper state pension increases.

Consultants LCP (Lane Clark & Peacock) warned that growing numbers of pensioners could be pushed over the tax threshold based purely on a state pension, adding that there is no automatic way of collecting the tax that they owe, because state pensions are paid in full, before the deduction of tax.

Sir Steve Webb, a former pensions minister who is now a partner at LCP said: “Millions of pensioners have been dragged into the tax net for the first time in recent years, primarily because of the multi-year freeze on tax thresholds. Many are now at risk of an unexpected letter from HMRC asking for tax they may not have realised was due."

HM Revenue and Customs (HMRC) may use a system called "simple assessment" in these circumstances. Under this system, at the conclusion of a tax year, the Department for Work and Pensions (DWP) would inform HMRC of the amount of state pension that an individual has received.

A person would have to pay taxes if this causes them to exceed the income tax threshold. HMRC may write to the pensioner after the end of the tax year telling them that they have not paid the tax due on their state pension and requiring them to make a payment before 31 January the following year, LCP said.

It warned that pensioners could have received – and spent – all of their pension during one financial year only to receive a tax bill on that pension the following year. For pensioners who have a state pension and a private pension, the state will collect any tax due through the code applied to the private pension.

Who will have to pay tax?

The income tax threshold has been frozen at £12,570 since 2021/22. This could mean pensioners receiving over £242 per week would owe some income tax. LCP said that online statistics from DWP indicate that, as at November 2020, over 2.3 million pensioners had a state pension of £195 per week or more, and taking account of state pension increases since then, these people would now have a pension over the tax threshold next year.

While some of these pensioners will have private pensions that can be used to collect any tax due, others will have large state pensions precisely because they did not make alternative private provision, it said. LCP estimates that around one in five of these pensioners, or more than 400,000 may have no other source of income from which HMRC can collect the tax owed.

This is the group who are now at risk of getting unexpected tax bills and may need to consider setting aside some of their state pension each month so that they have the funds available to pay a future tax bill, it said.

Sir Steve said: "Any pensioner with a pension next year over £242 per week will have tax to pay, and if they do not have a private pension through which the tax can be collected, they may need to set some money aside for an unwelcome tax demand.”

LCP believes many of those who could be hit by unexpected bills could be receiving the old state pension, having reached their state pension age by 2016. Under the older state pension system, some people will be receiving a full basic pension (of £156.20 per week) plus additional pension top-ups, which could push their total state pension into the tax bracket. The full new state pension is currently £203.85 per week.