Pensioners removed from self-assessment – does it make sense?

HMRC is removing certain taxpayers in receipt of state pensions from self-assessment – however, this does not mean that those taxpayers do not still have a responsibility to pay the correct amount of tax. As the state pension increases under the triple lock whilst the personal allowance remains frozen, more and more pensioners will be drawn into the tax net, with no clear mechanism to report their tax liabilities.

Self-assessment

For many years pensioners with a single source of income, being their state pension, have been required to complete a self-assessment tax return if their income is over their personal allowance, which may be the case if their basic state pension is enhanced by the state second pension. They have been paying their tax in January and July each year under the normal payments on account regime. 

HMRC has now written to a number of these taxpayers, removing them from self-assessment but without giving them a clear mechanism to pay their tax.

Simple assessment

It seems likely that HMRC is anticipating that these individuals will fall into the simple assessment system, whereby taxpayers wait for HMRC to issue a calculation after the end of the tax year, check this and then pay their tax by the following January. This system means that taxpayers lose control, in that they have to wait for HMRC to issue a calculation rather than completing their return when it is convenient for them, and also have to pay their tax in one go. Many taxpayers have therefore preferred to remain in self-assessment. Conversely, those that would prefer simple assessment cannot opt in themselves; only HMRC can initiate a simple assessment.

The future

As was confirmed in the Autumn Statement, the state pension will continue to increase under the triple lock; meaning that it will increase by the highest of consumer price index (CPI) inflation, average earnings growth or 2.5%. The increase in April 2024 will be 8.5%, taking the full new state pension to £221.20 a week, or £11,502 a year. Whilst this and a similar increase to the basic state pension is clearly very welcome for pensioners, the personal allowance has been frozen at £12,570 and is not scheduled to begin to increase by CPI until the 2028/29 tax year. 

This means that, if the full new state pension increases at a rate of 5%, from 2026/27 onwards it will increase beyond the personal allowance, dragging pensioners with this as their sole source of income into the tax net. 

For this group, paying their tax annually may be difficult from a cash flow perspective, as their liability could be as much as half a week’s income. Affected individuals may also find dealing with HMRC difficult and stressful, whilst for HMRC the cost of collecting this tax may be disproportionate, particularly if interactions by phone are required.

Potential options

There are various options that could be adopted to manage the consequences of pensioners coming into the tax net. For example, the state pension could be taxed at source, in common with most private pensions and employment income. Alternatively, the personal allowance could increase in line with the state pension to ensure that those with this as their sole source of income remain outside the tax net. A general increase in the personal allowance may not be favoured, so an alternative could be a return of the age-related personal allowance, with only those over state retirement age benefiting from these increases. An income abatement might also be considered for such an allowance, so that only those on the lowest incomes received the full allowance, thus remaining outside the tax net.

The key requirement for taxpayers (and HMRC) is to have a system that is easy to understand and has clear messaging, is simple to work with and largely stress free.

For more information, please get in touch with Sara Bonavia or your usual RSM contact.