Shielding poorest pensioners from income tax ‘to cost £500m a year’

John Healey’s plan to shield poorer pensioners from income tax risks costing the Government £500m a year within a decade, experts have warned. Economists and former ministers have criticised the Chancellor’s proposal to stop roughly a million retirees paying income tax, branding it costly and unfair. Mr Healey is expected to use his first Budget to confirm that the full state pension will rise by £489, or 3.9pc, to £13,036 , in line with average earnings. However, this would push almost a million people over the personal allowance threshold, which has been frozen at £12,570 until the start of the next decade, forcing these retirees to pay income tax for the first time. The Times reported that Mr Healey would stop this by creating a new tax allowance for low-income pensioners , aligning it with the full state pension at £13,036. Government sources indicated that Mr Healey’s fix to the problem would not involve a separate, higher tax-free allowance for low-income pensioners. Instead, the Treasury has asked HMRC to find an “administrative fix” that would effectively write off small tax bills at a cost of £200m by the end of the decade. Mr Healey’s proposed solution will come as a relief to poorer retirees, although Sir Steve Webb, the former pensions minister, said the fix was likely to be expensive and complicated. Sir Steve, now a partner at consultants LCP, said that the cost of the policy would rapidly increase over the coming years. Assuming earnings follow their historical path of 3.5pc a year and inflation remains close to the Bank of England’s 2pc target, Sir Steve said the cost could rise to £500m a year by 2035, representing a five-fold increase within seven years. ‘Embarrassing for the Government’ He compared the policy to the triple lock on pensions, which has become “hard to switch off”. Sir Steve said: “It is embarrassing for the Government that the repeated freezing of the personal allowance means that the new state pension will exceed the tax allowance for the first time next year.” With the state pension set to rise in line with average earnings in the long term, the gap between the pension and the tax allowance will grow each year and so will the cost of the scheme. The former minister also warned that the policy risked creating a new cliff-edge where pensioners earning even £1 above the full state pension could face tax bills of hundreds of pounds. “Having an extra tax allowance but only for poorer pensioners also risks creating cliff edges and distortions, especially as the value of this extra allowance rises each year,” he said. Sir Steve also warned that pensioners with small private pension pots could be tempted to cash in their savings early to qualify for the tax break, potentially leaving them with less money later in retirement. He said: “There is a real risk that a short-term fix becomes a long-term headache for the Government.” Martin Beck, of WPI Strategy, also criticised the move, saying: “This might sound like a compassionate measure, but it risks making an already complicated tax system even more convoluted, while creating a new source of unfairness. “Why should a pensioner receiving £13,036 a year pay no income tax, while someone earning exactly the same amount from working has to pay it? “Low-paid workers are hardly in a better financial position simply because they haven’t yet reached retirement age. “If the Chancellor believes the personal allowance is too low for people on modest incomes, there’s a legitimate question about why only pensioners should benefit. “Creating special tax rules for particular groups risks introducing further anomalies and unfairness into a system that desperately needs simplification.” While the Treasury previously indicated that only pensioners receiving the new or old state pension would qualify for relief, officials have broadened it to include pensioners receiving the old basic state pension alongside additional income from the State Earnings-Related Pension Scheme or a private pension, provided their total income remained below the threshold. A Treasury spokesman declined to comment.