The Conservative Party's proposed higher tax allowance for pensioners

The recent proposal by the Conservative Party to provide pensioners with a special (higher) tax allowance – rather than keeping their personal tax allowance frozen, in the same way it will be for regular taxpayers until April 2028 – appears to be another rushed idea from politicians, who are always ‘tinkering’ with the tax system but have no real strategy or ideas for what the tax system should look like to encourage the ‘right behaviours’ and ensure that there is a balance between the tax collected and the overall fairness and simplicity of the tax system.

What is the perceived problem?

The freezing of the personal tax allowance (until at least April 2028), combined with the ongoing increases in pensions – particularly UK state pensions – has resulted in an increasing number of pensioners becoming liable to a UK tax charge. This development has – in some ways – then been compounded by the fact that pensioners have not received any benefit from the government’s recent cuts to National Insurance.

The UK tax charge on pensions is a particular issue for those purely in receipt of state pensions – whether the basic state pension, SERPs or the state second pension or some combination thereof – as there is no mechanism to directly account for PAYE on state pensions.

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As such, while those individuals who also receive private pensions have any tax accounted for through an adjustment to their PAYE tax code (and hence collected via their private pension), pensioners purely receiving state pensions are now required to prepare annual tax returns to account for their UK tax charge. Moreover, the number of such tax returns which would be required in future years could expand significantly, while the regular personal tax allowance remains fixed at £12,570 a year.

Indeed, by 2027-28, it is estimated that even those people who only receive the basic state pension (so not SERPs or whatever), could be obliged to file an annual tax return, simply because of the workings of the ‘pensions triple lock’. It is also clear that HMRC doesn’t really have the resourcesto process a significant number of additional tax returns and – in reality – the ‘tax-take’ in many cases from having tax returns prepared by this group of people might actually be less than the cost of employing additional HMRC staff.

What is the proposed change?

The Conservatives have now – in very simple terms – promised that to avoid the above problem, they will guarantee that the personal tax allowance band for pensioners will – on a going forward basis – increase by ‘at least the pensions triple lock’. As such, whereas the personal tax allowance for regular taxpayers is frozen until at least April 2028, pensioners will be entitled to a higher personal tax allowance compared to the wider population.

What could this mean in practical terms?

While the proposal would help ensure that the number of pensioners needing to file tax returns is minimised – and as such could help reduce the pressures faced by HMRC – a development which should be welcomed by all advisers, given the difficulties that already exist in dealing with HMRC, the reality is that this appears to be a relatively ill-thought out and panicky announcement on the part of the Conservative Party.

For example, from a high-level perspective, it is the type of change which creates additional complexity (and indeed confusion) within the UK tax system. As such, it is easy to imagine, for example, that those pensioners who have ‘other income’ (say letting income or significant dividend or interest income), suddenly imagine that they no longer need to file UK tax returns, whereas such declarations would still be required to report this ‘other income’.

In addition, as things presently stand – and this might be clarified over time – it is not clear how the higher pensioners’ personal tax allowance would work with regard to other parts of the tax system. For instance, what would happen for:

Pensioners who earn over £100,000 a year? Specifically, what will happen about the ‘write down’ of the personal tax allowance which is presently reduced on a specific formula on income between £100,000 – £125,140 a year? The basic rate of tax and the relevant tax thresholds – would these thresholds change, so that slightly wealthier pensioners, for example, still qualify for exactly the same 20% tax band as a regular taxpayer? Or would there be some type of ‘rate band adjustment’, so that the 40% tax band, for example, continued to start at the same level of income for all taxpayers – whether pensioner or regular individuals?

Finally, it is also worth remembering that not all pensioners claim their state pension at the same age. Pensioners who ‘delay’ the receipt of their state pension – so that they can get a higher pension at a later date – could logically still be ‘caught out’ and be taxable on their state pension income if the new pensioner tax allowance is only a specific fixed amount and not something which takes account of that point.

This would not appear ‘fair’, and also wouldn’t encourage taxpayers to remain in the workplace beyond their retirement age, even though this is something which we probably need to encourage as a state – because of the aging workforce, for example.