The Chancellor plans to let pensioners off paying income tax if their total income – regardless of the source – matches the headline state pension.

John Healey will create a new Pension Tax Allowance of £13,036, the same as the full new state pension rate from next April, instead of the £12,570 for everyone else.

The new tax-free allowance for people over state pension age will rise in line with the headline annual payment until at least April 2030.

But a new taper will create what former pensions minister Steve Webb calls a 'bizarre' new 53 per cent tax rate for pensioners whose income ranges from £13,037 to £13,319. 

The Treasury says: 'The Government will introduce the Pension Tax Allowance, ensuring that pensioners whose total income is up to the value of the full new state pension do not have the administrative burden of paying small amounts of tax.

'The value of the PTA is calculated by applying the basic rate of income tax (20 per cent) to the difference between the full new state pension and the personal allowance.

'Individuals over state pension age are eligible for the automatic tax deduction if their income, regardless of source, is below or at the value of the full new state pension.

'For those with incomes just above the value of the full new state pension, the allowance will be gradually withdrawn through a taper. '

Those on just the full new state pension had been set to pay income tax on it for the first time from next April, as the annual amount would breach the income tax threshold of £12,570.

The headline state pension will rise by 3.9 per cent or nearly £500 a year to £13,036 next April under the triple lock, which guarantees an increase which is the highest of inflation, earnings growth or 2.5 per cent. 

'They will find that each £100 of annual private pension they have built up above the rate of the new state pension will add £53 to their income tax bill. 

'We are used to seeing high rates of income tax like this for top earners but not for those on very modest incomes. 

'Yet again, complexity has been introduced to the tax system to fix a short-term problem but with no long-term solution in mind.'

Webb explains that the maximum value of the break is around £94 in 2027-28. 

He says that for those just above this income level, the tax break will be reduced at a rate of £1 taken away for every £3 of income above £13,037. For those on £13,319 or above, the tax break will therefore be reduced to zero.

'However, this means that for pensioners in the range £13,037 to £13,319, they will face an effective tax rate of 53 per cent.'

Who could miss out on new tax break

Many older people who have private pensions on top of the full new state pension will still face an income tax bill, though a taper will help prevent a 'cliff edge'.

Some of the oldest pensioners could miss out on relief from income tax if they get a higher state pension under the old, pre-2016 system.

This is because many on the basic rate also get hefty top-ups, called S2P or Serps, if those were earned earlier in life, and these often push them into paying income tax already. 

People who retired before spring 2016 on the old basic state pension will see a £7.20 a week rise to £192.10, or around £10,000 a year, so that is still well below the new tax threshold.

People who get extra state pension above £13,036 a year because they delayed taking their payments could also lose out. 

Triple lock overhaul to go ahead

The Government today confirmed plans to ditch the state pension triple lock in favour of a double lock if it wins the next election.

At present, the triple lock pledge means the state pension should increase every year by the highest of inflation, average earnings growth or 2.5 per cent.

From 2030 the Government intends to increase state pensions based on inflation or 2.5 per cent, but still retain a link to long-term earnings growth.

It says: 'This adjustment will put the state pension on a sustainable footing, generate significant savings and materially improve the certainty of the state pension spending trajectory.

'It removes the "ratchet" effect, whereby the state pension rises ever higher relative to earnings. 

'Following the introduction of the adjusted triple lock, the state pension will track earnings over time.'

New pensioner tax allowance is 'sticking plaster'

'Protecting pensioners whose total income is no higher than the full new state pension from being dragged into the tax system is sensible,' says Jon Greer, head of retirement policy at Quilter.

'But this policy is also another sticking plaster over the cracks created by years of fiscal drag.

'The state pension has continued to rise while the tax-free allowance has stood still, and the Government is now having to engineer a workaround to prevent some of the lowest-income pensioners being caught in the middle.'

He went on: 'The Government has sensibly based eligibility on total income, rather than protecting only those whose sole income is the state pension. That avoids excluding someone simply because they saved a modest amount into a private pension.

'But the taper adds another calculation to retirement planning. The detail will determine how much of each additional pound of income pensioners keep.'

Zoe Alexander, chief policy officer at Pensions UK, voiced approval the Government has not introduced measures that could weaken incentives to save for retirement.

She says: 'We welcome action to ensure that the million pensioners with an income at or below the level of the state pension are not brought into paying income tax.

'The state pension provides the foundation of retirement income. Protecting the incomes of those most reliant on it is consistent with the wider objective of improving retirement adequacy.'

Got a pension question? Ask Steve Webb about the new Pension Tax Allowance or other news from the Budget at pensionquestions@thisismoney.co.uk. 

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