The new state pension may overtake the frozen personal allowance in a few years time.
For eligible individuals who reached their State Pension age after 5 April 2016, the new state pension will rise by 10.1% to £203.85 a week in April 2023. This amounts to £10,600 a year. The increase is in line with the Triple Lock, which uprates the main state pensions by the greatest of:
- consumer price index (CPI) inflation;
- earnings growth and;
- 5%
CPI was the dominant factor in the calculation this time, as earnings have failed to keep pace with soaring price inflation.
Personal allowance freeze or stealth tax?
While many other state benefits will also grow by 10.1%, the mirroring of inflation by the Department of Work and Pensions is not matched by HMRC. This means that the personal allowance will stay at £12,570 in April 2023, remaining at its two-year-old frozen level. It was due to start rising again from April 2026, but the Chancellor’s Autumn Statement added an additional two years onto that date, meaning the personal allowance will be frozen up to and including 2027/28. This is a total freeze of six tax years. It is the freezing of the allowances that is often referred to as a ‘stealth tax.’
Source: DWP, HMRC, OBR.
The impact of this lengthy frozen period is demonstrated in the graphic above – it shows the beginning of the new state pension in 2016/17 to 2023/24 and the Office for Budget Responsibility’s (OBR) projections for the level over the following four years. It also shows the gap between the personal allowance and state pension growing in each tax year. In 2019/20, the personal allowance was over £3,700 higher than the new state pension.
If the OBR’s projections are accurate, then by 2027/28 the difference between the new state pension and personal allowance will be about £360 – less than a tenth as much. The OBR’s estimate only needs to undershoot by 0.8% a year for the new state pension to be larger than the personal allowance in 2027/28. That could potentially cause problems for HMRC, because although the state pension is taxable, it is paid without deduction of tax, which could mean that tax returns are needed for a large proportion of pensioners.
Of course, it may not happen – 2027/28 is well after the next general election – but it should serve as a reminder both of how the income tax screw is being turned tighter and why income tax planning is becoming ever more important.
Tax treatment varies according to individual circumstances and is subject to change.
The Financial Conduct Authority does not regulate tax or benefit advice.
