We’re pensioners on under £13,000 – we’re worried about our tax bills

In our weekly series, readers can email in with any questions about retirement and pension savings to be answered by our expert, Rachel Vahey, head of public policy at investment platform AJ Bell. There is nothing she does not know about pensions. If you have a question for her, email us at money@theipaper.com. Question: My wife and I are both low earners and are worried about the amount of tax we will have to pay next year when the state pension goes up. We know the Budget made some changes on this front, but we are struggling to understand exactly how it affects us. I get the full state pension every four weeks. My wife does as well but she also has an annuity that pays £105 a year. We both got our state pension in 2023 when we turned age 66. Shorts Answer: The way taxation works for pensioners is changing from next April. And this is what the Chancellor covered in the Budget last week. First, a bit of background. Next April the state pension rises by 3.9 per cent to £13,037 a year. But the personal allowance – the amount you can receive before paying income tax – is frozen at £12,570. Left unchanged, that would have pulled some pensioners into paying tax for the first time, most of whom live off the state pension alone. The Government knew it had to act. Its solution is simple for some people but, unfortunately, quite complicated for others. Low earners over state pension age could get a little extra tax-free allowance on top of their normal personal allowance. It’s called the Pension Tax Allowance and next year it will be worth £467. That means pensioners with income that does not exceed £13,037 will receive this (£12,570 plus £467) without paying tax – so anyone living only on the full new state pension won’t pay any tax at all. The catch is that this extra allowance is only for those on low incomes. If your income is above £13,037, then the Pension Tax Allowance is cut by £1 for every £3 over that level. Once your income goes above £13,413, it disappears completely and you’ll pay tax on everything above £12,570. So what does this mean for you both? The good news is that, as you receive the full new state pension of £13,037 a year, you’ll get the full Pension Tax Allowance and won’t pay any tax. This allowance has been designed for you. Your wife’s situation is a little different. Because her state pension and annuity together take her total income above £13,037, she will pay some tax – but the Pension Tax Allowance will help reduce her bill. Here’s how the sums work. Her full new state pension of £13,037 plus her annuity of £105 a year gives her a total income of £13,142 – £105 above the £13,037 threshold. Her £467 Pension Tax Allowance is reduced by £1 for every £3 over that threshold, so that’s a £35 cut that brings it down to £432. Add that to her normal £12,570 personal allowance and she can receive £13,002 tax-free. That leaves £140 of her income (£13,142 less £13,002) to be taxed. At 20 per cent, that would be £28 in tax. Your wife should not have to contact HMRC to make a claim for the Pension Tax Allowance. It should be applied automatically using the information HMRC holds about her income. Although this new allowance will help many low-earning pensioners to pay no or less tax, there’s no doubt this new tweak to the tax rules can be tricky to get your head around – especially if your total income falls between £13,037 and £13,413, where the Pension Tax Allowance is gradually whittled away. For pensioners with income above £13,413, there is no effect from the introduction of the Pension Tax Allowance.