Osborne urged not to tax pensions

HM Treasury’s tax advisers have suggested that more than five million middle-class retired people could be freed from paying income tax on their state pensions.

In a move that would be worth up to £1,000 a year each, the Office for Tax Simplification said that scrapping the levy should be considered because many pensioners considered it “unjust”.

A report by the advisers has condemned “confusing”, over-complex tax rules facing people in retirement.

HM Revenue and Customs estimates that almost 5.6 million people receiving the basic state pension pay income tax; usually because private pension payments and savings interest take their total income above the tax threshold.   As a result, more than 1.5 million pensioners have to fill in a self-assessment form.

In the report to Treasury ministers, the advisers said that there was a “patchwork of allowances and rules which many in their later years find very confusing” and that taxing the basic state pension made the system significantly more complicated.

Fewer than half of all retired people are even aware that state pension income is subject to tax like regular income.

“Many of those who do understand that it is taxable feel that this is unjust, given that they have contributed through the national insurance system through their working life,” the report said. Among the options identified by the OTS was: “Exempt the state pension from tax altogether.”

A full basic state pension is worth £5,311 a year. Exempting that sum from the 20 per cent basic rate of income tax would be worth around £1,060.

A Treasury spokesman said that ministers would respond to the report in the Budget later this month, but did not expect formal recommendations until later this year.

The government is also looking into replacing the current means-tested system of pension credits with a single universal state pension of around £130 a week and making all state pension payments through the PAYE system, so that they are taxed at source.  This move could reduce the number of older people who find themselves burdened with self-assessment.

Michael Jack, the former Conservative minister who chairs the OTS, said: “It is the operation of the age allowance, the tax status of the state pension and the way the system deals with certain types of savings income that causes the greatest confusion.”

Pensioners also have a higher tax allowance than younger people, with the threshold for those aged between 65 and 74 currently set at £9,940. The threshold for younger people is £7,475.

 The OTS suggested that the higher tax allowance should be abandoned, especially since the Coalition is committed to increasing the starting threshold for all taxpayers to £10,000.

Abolishing age-related thresholds could partly offset any benefit that may arise from ending or reducing tax on the basic state pension, it said.

Ros Altmann, the director-general of Saga, said that any move to exempt the basic state pension from income tax would be “warmly welcomed”, not least because of the recent pressure on pensioners’ incomes from inflation and the Bank of England’s quantitative easing policy.

But she warned against any reduction of the tax threshold for pensioners.

“The thrust of policies in recent years has been to take money away from pensions,” she said.  The current government seems to see pensioners as a valid target for taking money, particularly middle-income pensioners.”

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