Why private pension savings will cost you more in tax from 2027

Who this issue affects:

• Anyone who receives (or will shortly receive) the State Pension, and;
• Anyone who receives (or will shortly receive) a private or workplace pension in addition to the State Pension

Why are people worried about what will happen to pensions in 2027?

The full new State Pension is expected to rise to more than £12,570 per year from April 2027, overtaking the £12,570 Personal Allowance. The Personal Allowance is the amount of income each person in the UK can earn without needing to pay any tax.

And crucially, the State Pension is taxable.

Until recently, the State Pension has always been below the Personal Allowance threshold, so someone whose only income was the full State Pension didn’t need to worry about tax.

But there’s now a problem because the State Pension has continued to increase under the Triple Lock. The Triple Lock is the government’s guarantee that the State Pension will increase each year by whichever is highest: inflation, average earnings growth, or 2.5%.

At the same time, the Personal Allowance has been frozen for many years. This creates a situation where some pensioners could, in theory, have to pay income tax on part of their State Pension for the first time ever.

The issue is further complicated by the fact that no tax is deducted from the State Pension when it’s paid. Normally HMRC collects the tax by either:

• Changing the tax code on your private pension or salary if you receive one, or;
• Sending a Simple Assessment tax bill if you have no income other than the State Pension.

So does that mean, if I receive the State Pension, I will have an income tax bill to pay from April 2027?

No.

The government has said that, for the time being, it does not intend people whose only income is the State Pension to have to pay income tax, even if the State Pension becomes higher than the Personal Allowance. Exactly how this will work in terms of the law and how it’s administered, is still being worked out though.

But that does mean that if you rely solely on the State Pension for your retirement income, you will be exempt from paying any income tax and, effectively, nothing will change for you.

For someone with a private or workplace pension in addition to the State Pension, what will change in April 2027?

If you receive both the State Pension and a private or workplace pension, you won’t benefit from this exemption.

Anything you receive (including from the State Pension) over the Personal Allowance threshold, will be taxed.

That means more of your Personal Allowance will be used up by the State Pension leaving less of it to cover your private pensions.

This is an example of ‘fiscal drag’. You’re not paying a new tax, but more of your income falls into the taxable band because the allowance hasn’t kept pace with pension increases.

For example…

• Before April 2027:

Let’s say you receive the State Pension (£12,500 per year) and workplace pension (£8,000 per year), so your total annual income is £20,500.

The State Pension uses almost all of your £12,570 Personal Allowance, leaving around £70 of allowance for your workplace pension.

So you’d pay tax on about £7,930 of your workplace pension.

• After April 2027

Now suppose the State Pension rises to £12,850. That is £280 above the Personal Allowance.

The first £12,570 is covered by your Personal Allowance, but the remaining £280 is taxable. And your workplace pension is still taxable too.

So your taxable income becomes:
£280 from your State Pension
£8,000 from your workplace pension

You’d now pay tax on £8,280 of your income.

Compared with the previous year, you’re paying tax on an extra £350, because the higher State Pension has pushed more of your income above the frozen Personal Allowance.

Isn’t that a bit unfair?

Yes, it creates a group of people who don’t have to pay tax on income above the Personal Allowance, and a group of people who do.

We’ve had many readers complain that this decision punishes those who have diligently put money aside throughout their working lives to have a private/workplace pension to fall back on in retirement.

Given that The UK State Pension is one of the least generous in the developed world when compared with average earnings, it isn’t surprising that those who rely on workplace and private pensions to top it up, feel this is an unfair penalty – and that it disincetivises saving into a pension.

That said, people who already receive a combination of State Pension and a private or workplace pension already pay tax on anything above the Personal Allowance threshold – that isn’t changing. The unfairness could be seen in the fact that a group of people are being exempt from tax above the threshold, while others are not.

Will those who have a private pension in addition to the State Pension have to start completing a tax return from 2027?

Not necessarily. Almost nothing changes in how your tax is calculated from April 2027 so if you’re already paying income tax on some of your pension income, then it’s likely the status quo will continue for you, unchanged.

Even if you’re in the small group of people whose income will now tip over the Personal Allowance for the first time with the next State Pension increase, private or workplace pension providers operate PAYE, just like an employer. So, your tax will be collected automatically without you needing to do anything.

HMRC simply adjusts your tax code so the correct amount of tax is deducted from your private pension payments throughout the year. You don’t suddenly start paying tax directly on the State Pension itself – the extra tax is normally collected from your other pension.

Why doesn’t the government just make the State Pension tax-free?

That would simplify things in one way – but it would complicate things in other ways.

The government wants the State Pension to remain part of the normal income tax system, rather than creating a special tax exemption.

The State Pension has always been taxable. Changing that would be a major shift in tax policy. The UK tax system generally taxes total income rather than different types of income differently. Making one type of pension income permanently tax-free would be a departure from that principle and could prompt calls for similar treatment of other pensions.

For someone who only claims the State Pension, what (if anything) will change in April 2027?

If your only income is the State Pension, the practical answer is, practically nothing changes.

Although the full State Pension is expected to rise above the Personal Allowance from April 2027, the government says pensioners who only receive the State Pension and have no other taxable income, will not have to pay income tax.

They’ve only said this exemption applies until the next election though, so watch this space for possible future changes.

What about if you receive benefits in addition to the State Pension?

Not all state benefits are treated the same way, so what you receive will determine whether you need to pay tax.

Benefits that are taxable include:

• Bereavement Allowance
• Carer’s Allowance (if your total taxable income exceeds your Personal Allowance)

Benefits that are not taxable include:

• Personal Independence Payment (PIP)
• Attendance Allowance
• Disability Living Allowance (DLA)
• Housing Benefit
• Pension Credit
• Housing Benefit
• Child Benefit (although there can be a separate High Income Child Benefit Charge)

If a benefit you receive in addition to the State Pension is not taxable, then you will still be exempt from paying income tax when the State Pension rises above the Personal Allowance threshold.

The State Pension protection has been described as applying to people whose only income is the State Pension. If you therefore also receive Bereavement Allowance, for example, (which is taxable), then you would no longer fall into that category. One important thing to note is that we are still waiting on the detailed legislation and HMRC guidance around this policy. The government’s commitment has been framed in terms of protecting people whose only income is the State Pension, but the precise legal wording will determine exactly how edge cases are treated.