Over 8 million state pensioners to be hit with new ‘retirement tax’ over next three years – and how to avoid

MILLIONS of retirees are set to pay income tax on their pensions for the first time over the next three years, fresh figures show.

In total, 8.2million people over the age of 60 will be dragged into paying income tax by 2027/28, according to analysis by HM Revenue & Customs (HMRC).

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And those are only some of the millions of households expected to have to start paying income tax as a result of the ongoing freeze to tax thresholds.

Data provided by HMRC through a freedom of information (FOI) request by wealth manager Quilter, shared exclusively with The Sun, shows nearly 18million people will be forced to pay income tax overall.

Of those, 11.6million will be affected over the next three years, with 8.2million of those individuals over the age of 60.

This suggests millions of people in receipt of state pension or other pensions will start paying tax on their retirement income for the first time.

Additionally, 12million people are set to be dragged into the higher rate of income tax, which is 40% of any income over £50,271, with 8.2million expected to be hit in the next three years.

Normally, tax thresholds increase every year to account for the fact that wages have risen in line with inflation, as this stops people being left worse off in real terms.

But in April 2021, the then-Conservative government decided to freeze all tax thresholds, and these are now due to stay frozen until 2028.

It did this to raise extra cash, as freezing the thresholds means more people would pay tax, or pay tax at a higher rate.

This process is known as fiscal drag, where workers are dragged into higher tax brackets as their pay has increased with inflation but the tax thresholds have not changed.

For pensioners, the triple lock – which ensures the state pension rises by the highest of inflation, 2.5% or wage growth – boosts the state pension while thresholds don’t rise with it.

But inflation has risen dramatically since thresholds were first frozen, peaking at over 11% in November 2022 compared to the country’s target of 2%.

This has meant wages and the state pension have had to increase more than usual to keep up with rising costs.

As a result, the number of people set to be affected by the frozen thresholds has soared since the measure was first introduced.

Originally, the government predicted that around 1.3million people would be dragged into paying income tax, with a further one million people paying at the higher rate.

But the latest figures show this has leapt up to almost 30million people affected in total, with 18million starting to pay tax and 12million paying at a higher rate.

Rachael Griffin, tax and financial planning expert at Quilter, told The Sun: “The number of people expected to pay income tax for the first time, or at a higher rate, by 2027/28 is set to rise exponentially due to the continued freeze on tax thresholds. 

“As incomes rise, including state pension income, more people are being dragged into paying tax for the first time or into higher tax brackets, a phenomenon known as fiscal drag.

“Even without an explicit tax rise, the government will continue to collect more from taxpayers each year by keeping thresholds static.

“What’s more, as the state pension rises while the personal allowance remains stagnant, many pensioners will soon find themselves having to pay back a proportion of their state pension.”

Around 650,000 pensioners were forced to start paying income tax from this month as a result of fiscal drag.

It came after the state pension increased by just over £470 a year from April 6.

How can I protect myself from paying tax?

There are a number of measures you can take to mitigate the amount of tax you have to pay.

One way is to take advantage of all the tax-free incentives on offer.

For example, make sure to put any savings into an ISA. These savings vehicles let you deposit up to £20,000 per year, and any interest or returns you earn are tax-free.

And it is not just the interest you earn on them that is tax-free, but any withdrawals too.

For example, withdrawing 4% a year from a £100,000 ISA pot in retirement would amount to £4,000 of tax-free income each year, compared to taking it out of a regular savings account, which is subject to tax.

This could also be a good time to take advantage of pension savings.

You can save money into a pension tax-free, and any money saved into your retirement pots then has the opportunity to grow tax-free over time.

You can then withdraw up to 25% of your pot tax-free when you reach retirement age.

You can either do this as a lump sum or in smaller gradual amounts to top up your state pension without being taxed on it.

“Strategic financial planning has never been more important,” Ms Griffin said.

“Some will be able to mitigate their tax burden with options such as salary sacrifice arrangements and increasing pension contributions, whereas retirees should explore how they are taking income to ensure they are not paying more tax than necessary.”

For married couples, consider taking advantage of the marriage allowance.

Marriage Allowance lets you transfer £1,260 of your personal tax allowance to your husband, wife or civil partner.

This currently reduces their tax by up to £252 a year.