Labour Prime Minister Andy Burnham and Chancellor John Healey have committed to shielding state pensioners who rely solely on the state pension from income tax, but a new analysis warns that millions of pensioners with additional state pension top-ups will still face tax bills.
Former Liberal Democrats Pensions Minister Steve Webb has branded the policy a “sticking plaster solution” that is “deeply flawed.” The warning comes as the full state pension is set to exceed the basic income tax threshold from next spring, creating a tax liability for many pensioners.
Labour's Pledge Falls Short for Millions
In a move to honour a commitment made by Rachel Reeves, the Labour government has vowed not to tax pensioners who live entirely on Department for Work and Pensions (DWP) payments. However, Webb points out that this exemption will only apply to those receiving the basic state pension alone, leaving a significant gap.
“The vast majority of Britain's pensioners will not be eligible for the Labour Party Government's plans to exempt certain pensioners from income tax from 2027,” Webb said. His analysis reveals that approximately 6.5 million pensioners also receive additional state pension top-ups, known as S2P (State Second Pension) and Serps (State Earnings-Related Pension Scheme), which were earned during their working lives. These pensioners would not qualify for the income tax exemption.
Webb explained that someone on the old system with a basic plus additional state pension of exactly the same value as the new state pension will still have to pay tax, because they are not “solely dependent” on the old basic pension. This creates an unfair disparity between pensioners with identical total pension incomes.
Reeves' Commitment and Its Limits
The policy stems from a commitment made by Rachel Reeves during an ITV interview with Martin Lewis in November. Reeves, then Chancellor, confirmed that pensioners with only a state pension would not be required to file a tax return. “So if you just have a State Pension, you don’t have any other pension, we are not going to make you fill in a tax return… I make that commitment for this Parliament,” Reeves said, but hinted that she was “working on a solution.”
When Lewis pressed for clarification on whether pensioners would still have to pay the tax, Reeves insisted: “In this Parliament, they won’t have to pay the tax.” However, this assurance appears to apply only to those with the basic state pension, not to those with additional top-ups.
Criticism and Calls for Reform
Webb argues that the government's approach is overly complex and fails to address the root problem. “A general write-off when people have small amounts of tax would probably be a cleaner solution, though a more fundamental review of pension and tax allowance levels is clearly needed,” he said.
The warning highlights a growing concern among pensioners who have contributed to S2P or Serps throughout their careers. These top-ups were designed to provide a higher income in retirement, but under the new tax rules, they could inadvertently push pensioners into a higher tax bracket.
Impact on Pensioners
From April 2027, the full new state pension is expected to exceed the personal allowance, currently set at £12,570. This means that even pensioners with no other income will see their state pension become taxable. For those with additional top-ups, the tax liability will be even greater, as they will have a higher total income.
Webb's analysis suggests that the government's exemption for “solely dependent” pensioners is too narrow. Many pensioners on the old state pension system, who have built up additional entitlements, will be left out. This could lead to significant tax bills for a group that Labour had promised to protect.
Political and Public Reaction
The news has sparked debate among pensioner groups and political commentators. Critics argue that the policy creates a two-tier system, where some pensioners are protected from tax while others with similar incomes are not. Labour supporters, however, point out that the commitment to avoid tax returns for basic state pensioners is a step forward, even if it doesn't cover all cases.
Burnham and Healey have reiterated their commitment to Rachel Reeves' original vow, but the pressure is mounting for a more comprehensive solution. Webb's call for a fundamental review of pension and tax allowance levels is likely to gain traction as the 2027 deadline approaches.
Looking Ahead
As the full state pension continues to rise, the interaction between pension income and income tax will become an increasingly pressing issue. The government may need to reconsider its approach to ensure fairness for all pensioners, regardless of their pension type.
For now, pensioners with S2P or Serps top-ups face an uncertain future, with the prospect of tax bills on their state pension income from 2027. The Labour government's pledge, while well-intentioned, appears to be a temporary fix that leaves many vulnerable pensioners exposed.
