An increase that might look good on paper crumbles into utter insignificance when proper analysis is applied.
Pension increase may seem positive – but the reality is very different (Image: Getty)
An increase of over £560 per year in the rate of the new state pension next April could sound like a bit of a windfall. But the reality will be very different. Although an increase of 4.7% – in line with the growth in the average wage – is welcome, much of this will be eaten up by rising prices. The Bank of England expects inflation to hit 4% this Autumn, which means that more than £470 out of the £560 rise will simply be needed to meet increases in the cost of living.
On top of this, income tax is another sting in the tail. At the moment, nearly three in four pensioners has to pay income tax and that number grows every year as the income tax threshold remains frozen. For most pensioners, at least 20% of the £560 rise – or over £100 – will go back to the Government in income tax.
This means that a combination of rising prices and a rising tax burden will mean millions of pensioners may feel no better off next year than this.
The freezing of the tax threshold also means that more pensioners will have to start paying tax in retirement for the first time.
If they have a state pension and a company pension, the Government will use the ‘tax code’ on the company pension to collect any tax due. But if they only have a state pension, the Government will need to collect tax some other way.
The normal process is that HMRC will look at the end of the tax year at your total income and work out how much tax you should have paid.
If no tax has been collected then you will be issued with a ‘simple assessment’ tax demand after the end of the tax year.
Whilst this mostly means it won’t be necessary to file a tax return, it does mean getting an unwelcome letter each year from the tax office.
It also means having to set aside some money each year to cover the tax bill that will eventually land on the doormat.
No doubt there will be stories about how well pensioners are doing and about how ‘generous’ the triple lock rule is for state pensioners.
But you don’t have to look far below the surface to see that for many pensioners, money will remain very tight.
Former Pensions Minister Sir Steve Webb is a partner at pension consultants LCP
