The number of pensioners paying income tax is on the rise, driven by higher state pensions and frozen tax thresholds. New figures from the tax office reveal that 7.13 million people of pension age paid tax in the 2022/23 tax year, marking a 5.7% increase from the previous year.
Commenting on HM Revenue and Customs (HMRC) 2022/23 figures, Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “Pensioners were paying a significant chunk of tax.” However, she warned: “Frozen tax thresholds, coupled with increased state pensions, may pull more pensioners who are solely reliant on state pension into taxpaying territory.”
In 2022/23, the full new state pension was £185.15 per week, or £9,627.80 annually, which accounted for more than three-quarters of the £12,570 personal allowance. By 2025/26, the full new state pension will rise to £230.25 per week or £11,973 per year.
This will use up 95% of the personal allowance, leaving just £597 of income before pensioners are liable to pay income tax.
With the triple lock still in place, if the state pension continues to rise by at least 2.5%, it is expected to surpass the £12,570 personal allowance by the 2027/28 tax year. This would mean that all pensioners receiving the full new state pension will soon be required to pay tax on a portion of it.
Shaun Moore, tax and financial planning expert at Quilter, added: “Pensioners are often among the worst hit by frozen tax allowances.” He explained that this is because they often also rely on income from various investments, making them more dependent on capital gains tax and dividend allowances to supplement their pension.
However, with the Government making it “very difficult” to avoid heavy taxes on these types of investments, Mr Moore added: “It is vital that people look across the spectrum of financial products that provide tax efficiency and use them in the right way.”
Echoing this, Ms Morrissey pointed out the importance for older people to carefully plan their retirement income and balance income from different sources. She explained: “For instance, you can make use of the tax-free income from an ISA alongside your pension or employment income to make sure you don’t breach a threshold into paying tax at a higher rate.”
Cash ISAs allow savers to grow their money tax-free on interest up to the £20,000 annual allowance without being subject to the Personal Savings Allowance (PSA).
Currently, basic-rate taxpayers can earn up to £1,000 in interest tax-free, and higher-rate taxpayers have a £500 allowance. Additional-rate taxpayers receive no exemption and are taxed on all interest earned outside of tax-free accounts.
In the 2022/23 tax year, around 69% of taxpayers – approximately 15.3 million people – earned savings interest, with an average of £337.
Ms Morrissey said: “The average interest earned rises with incomes, and at the same time, the tax-free allowance halves and then disappears as you cross tax thresholds. It means higher earners are much more likely to pay tax on interest.”
She added: “ISAs are particularly valuable for higher earners who have a smaller savings allowance and pay a higher rate on the excess.”
Four million taxpayers received dividend income, which includes both business owners who pay themselves dividends and a significant number of investors. To protect against both dividend tax and capital gains tax, Ms Morrissey recommended investing in a stocks and shares ISA, as these are exempt from both taxes.
Ms Morrissey said: “If you have existing investments outside an ISA and the available allowance, you can use share exchange (bed and ISA) to move them into the ISA and protect them from tax. Take care not to exceed your capital gains tax annual allowance of £3,000 in the process, though.”
