Stealth tax snares army of pensioners: Thousands into clutches of HMRC

The number of retirees forced into income tax is set to hit a record 8.5 million next year following a controversial raid by Chancellor Jeremy Hunt.

The combination of Hunt’s tax threshold freeze and rising inflation will mean that another 800,000 older Britons will have to pay taxes on their modest retirement income after working all their lives.

It means that about two-thirds of those over 65 on state pensions with only a small amount of additional income from a company pension or other nest egg fall into the tax trap.

The figures, compiled by former Pensions Secretary Steve Webb, are likely to fuel calls to stop burdening relatively low-income retirees with tax demands, or at least to reduce the amount of tax they have to pay.

“Most British pensioners have worked for decades and most paid their taxes to the then government,” said campaigner Ray Crawford, who has launched an online petition to force MPs to debate the issue. “Why do we have to pay these taxes in our last years?”

The stealth tax grab has its origins in a little-noticed move by Rishi Sunak when he was chancellor. In 2021, Sunak introduced a four-year tax threshold freeze, pinning the personal deduction – the point at which employees start paying income tax – at £12,570 from 2022 to 2026. Hunt extended the freeze for a further two years.

Runaway inflation means taxpayers will be taking billions of pounds more out of taxpayers’ pockets than originally thought. Retirees receiving raises to keep pace with rising prices will be affected.

It was initially estimated that the four-year freeze would bring in £8 billion, but rising inflation means it will bring in much more.

The state pension, which is linked to the rate of inflation, rose 10.1 percent in April, adding another half million people to pay income taxes, according to Webb’s analysis.

Those who receive the full amount will now receive £203.83 per week, equating to an annual income of £10,600. This is only £1,970 below the level at which they will have to start paying tax – so even a modest company pension or savings income will push them into the throes of the tax authorities.

The next pension increase will be based on the level of the Consumer Price Index (CPI) in September.

With inflation stubbornly high, Webb estimates that at least 300,000 more retirees will pay income taxes next year. This assumes a 7 per cent increase in state pensions – equivalent to an increase of £742 a year.

Webb, now a partner at pensions consultancy LCP, said: ‘The continued freezing of tax thresholds at a time of continued high inflation will drag more and more retirees into the tax net.

“We have already seen an increase in the number of tax-paying retirees over the past decade and this is expected to continue.

“This stealth tax means that the majority of working-age people now face the prospect of paying income tax when they retire.”

A Freedom of Information request from Webb found that nine out of 10 retirees who pay taxes do so at the base rate of 20 percent.

Of the 12.2 million people who received state pension last year, 7.7 million paid income tax. Of these, 671,000 paid the higher tax rate of 40 pence, while a further 65,000 paid the top rate of 45 pence in the pound.

The government will rake in an additional £120bn over the next five years because of ‘fiscal drag’, quietly pulling workers into higher tax brackets when they receive pay rises. Even an inflation-related wage increase for pensioners does not lead to more purchasing power.

The watchdog of the Office for Budget Responsibility estimates that 3.2 million people will start paying taxes for the first time, while a further 2.1 million people will pay the higher rate of 40 pence and a further 350,000 will pay the top rate of 45 pence .

By 2028, the tax burden will be at a post-war peak of 37.7 percent of annual economic output.

The number of pensioners paying taxes has risen sharply from 4.5 million in 2010, while the ‘triple lock’ has remained in place. This guarantees that the state pension will increase every April in line with September’s highest inflation rate, income growth or a rate of 2.5 percent.

The triple lock was suspended during the pandemic to avoid the government having to increase pension payments by 8 percent after wage inflation was artificially driven up by workers coming out of furlough and back on the payroll.

The Ministry of Finance was asked for comment.