How will the new state pension tax-free allowance work? STEVE WEBB explains

A new Pension Tax Allowance announced in the Budget will let the poorest pensioners off paying income tax. Steve Webb, a partner at LCP and This is Money's pension columnist, explains how it will work.In April 2027, the standard rate of the new state pension will rise to £250.70 per week, or £13,036.40 per year.As this is above the (still-frozen) tax threshold of £12,570 it would have meant someone with no income other than the state pension facing a tax bill of just over £93.As the state pension rises further in 2028 and 2029, that bill could have reached more than £200 if nothing was done.Following the Budget, we now know that someone in this position will not pay income tax over the next three years.But the Chancellor went further and introduced some easement (on a sliding scale) for those slightly above the new state pension level. So how, exactly, will all of this work?New allowance covers income from any sourceThe easiest way to understand all of this is as a new ‘tax rebate’ for pensioners whose income is just above the income tax threshold.The Treasury has said that for those with incomes between the tax threshold of £12,570 and the new state pension rate – rounded up to £13,037 – no tax will be payable.As 20 per cent of this band comes to £94 (rounded up), people in this band will get a rebate of up to £94 to wipe out their tax bill.Note that if you are in this income band, it won’t matter *where* this income comes from.It could be the new state pension, an old basic pension plus additional pension, an old basic pension plus occupational pension or any other combination.What will matter will be the amount of taxable income, not its source.What if your income is just above the new allowance?For those whose income is just above the £13,037 cut-off, this rebate will fall by £1 for every £3 over the cut-off.For example, for someone with £60 above the cut-off (so an annual income of £13,097), £20 will come off their rebate.This means they will pay their normal tax – on everything above the standard tax threshold of £12,570 – but will then get a rebate of £74.The Government say that the help will run out at £13,319. This is because someone at this level has £282 above the new state pension rate, so loses £94 in rebate, reducing it to zero.It means that pensioners in the income range £13,037 to £13,319 will face an effective tax rate of 53 per cent Do you need to take any action?In terms of how this will work in practice, the Government is at pains to stress that there will be no application process.Where someone simply has a full new state pension, the end year tax check by HMRC will apply the rebate and reduce the tax bill to zero.Where someone has additional income such as a company pension, the ‘tax code’ issued to the pension provider should reflect the new rebate system, and the right amount of tax should be collected over the course of the year.The definition of income used to work out how much rebate you qualify to receive is simply your normal taxable income figure.This means that, for example, if you have a small amount of taxable interest income but this is currently covered by the £1,000 Personal Savings Allowance, then it will not count against you when working out how much of the new pensioner tax rebate you can get. What about the Marriage Allowance?In terms of other issues, there is the potential interaction with the Marriage Allowance to consider.This is a system which currently allows a non-taxpaying spouse (or civil partner) to transfer 10 per cent of their unused personal allowance (£1,260) to a spouse who is paying basic rate income tax.In future, a couple can receive this new tax rebate and use the Marriage Allowance where they meet the conditions for both. But – crucially – the new rebate calculation will be done first.In simple terms, this means that everything described above is done as if the Marriage Allowance did not exist.If, after all of that, a member of a couple is still paying income tax, they can receive a transferred allowance from a non-taxpaying spouse.You can read the Government’s explainer as to how the new Pension Tax Allowance will work here, along with FAQs and worked examples. Ask Steve Webb a pension question Former Pensions Minister Steve Webb is This Is Money's Agony Uncle.He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.Steve left the Department of Work and Pensions after the May 2015 election. He is now a partner at actuary and consulting firm Lane Clark & Peacock.If you would like to ask Steve a question about pensions, please email him at pensionquestions@thisismoney.co.uk.Steve will do his best to reply to your message in a forthcoming column, but he won't be able to answer everyone or correspond privately with readers. Nothing in his replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.Please include a daytime contact number with your message - this will be kept confidential and not used for marketing purposes.If Steve is unable to answer your question, you can also contact MoneyHelper, a Government-backed organisation which gives free assistance on pensions to the public. It can be found here and its number is 0800 011 3797.Steve receives many questions about state pension forecasts and COPE (the Contracted Out Pension Equivalent). If you are writing to Steve on this topic, he responds to a typical reader question here. It includes links to Steve's several earlier columns about state pension forecasts and contracting out, which might be helpful. SIPPS: INVEST TO BUILD YOUR PENSIONAJ BellAJ Bell0.25% account fee. 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