Rachel Reeves sets brutal state pension tax trap – you’ll regret saving a single penny.uk

Thanks to her, the personal allowance is frozen at £12,570 all the way to 2031. Yet the state pension will continue to increase by either earnings, inflation or 2.5%, under the triple lock. Today, the full new state pension is worth up to £12,547 a year, a fraction under the personal allowance. The Office for Budget Responsibility predicts it will rise 3.7% next year to £13,012. And that’s where the problems begin. For Reeves, HMRC and millions of pensioners.

An increase of 3.7% would push the new state pension £442 above the frozen personal allowance. This will create a politically toxic situation where the state pension itself becomes taxable – hitting the lowest income pensioners. In this scenario, someone purely on the new state pension would face an instant £88 tax bill. And that bill will rise every year until 2031. This triggered an outcry, and Reeves panicked and came up with a quick fix. She promised that retirees whose only income comes from the state pension won’t pay income tax during this Parliament.

Her pledge sounded reassuring, but it’s quickly turned into a gruesome can of worms. It’s both aggravating a long-standing problem with the state pension, and punishing savers who set money aside for retirement. And there’s no easy way out.

I covered the first of these two issues on Monday. The UK has two state pension systems running side by side. Around five million retirees who reached pension age from April 6, 2016 receive the new flat-rate state pension. If they have absolutely no other sources of income at all, Reeves’s pledge just about works for them.

But older retirees are in a different position. Roughly 7.7million still receive the older basic state pension, which pays significantly less. This year, it’s worth just £9,615.

Most get additional state pension on top of that basic amount, typically through Serps or the state second pension (S2P). Unfortunately for them, these top-ups are taxable today and will remain taxable.

That means millions of older pensioners who breach the personal allowance won’t benefit from Reeves’s pledge, even if they live purely on the state pension. And even if younger pensioners on the same or more income escape tax. What a mess. In total, Reeves’s tax pledge will help a mere one in 20 pensioners.

Now, another nasty wrinkle has emerged, highlighted by former Pensions Minister Steve Webb at consultancy LCP. And this one affects both those on the new state pension AND basic state pension.

Incredibly, it will punish those who did the responsible thing, and saved even a tiny amount of money for retirement.

Thanks to Reeves, low-income retirees now face a costly cliff-edge. The moment they earn even £1 extra from a private pension, savings interest or part-time job, Reeves’s promise unravels.

They won’t just face a tax bill on that income. But on the slice of state pension above the frozen personal allowance too.

By 2029/30, LCP estimates the new state pension could hit £13,671. At that point, just £1 of additional income could trigger a tax bill of around £220.

That’s an extraordinary outcome. Reeves’s plan will tip them over what will be the sharpest cliff edge in the entire UK tax system (and there are plenty of those).

For years, governments urged people to save for retirement and ease pressure on the state. Reeves has somehow managed to create a system where pensioners who saved modestly could end up worse off than those who saved nothing at all. And every year the tax thresholds remain frozen, the madness will multiply. It’s yet another disaster, courtesy of Rachel Reeves.