Hargreaves Lansdown warns millions of pensioners set to be dragged into paying income tax

A total of 8.7 million pensioners are expected to pay income tax on their retirement funds by the 2025/26 financial year, according to the latest projections from HM Revenue and Customs (HMRC). That is a rise compared to the prior year's 8.28 million and an increase of nearly 1.85 million over a decade since 2015/16.

Pension expert Helen Morrissey from Hargreaves Lansdown has raised alarms about more retirees being swept into the taxpaying bracket, attributing this trend to so-called frozen income tax thresholds - a tax starting point that is not currently rising with inflation. Such thresholds drag more into paying tax as incomes rise but the threshold stays the same, and they are widely seen as a government stealth tax.

With Personal Allowance levels expected to be fixed at £12,570 until April 2028, coupled with forecasts that the New State Pension will exceed this amount by April 2027, there's growing concern among pensioners. The current full New State Pension is reportedly at £11,973 for this fiscal year, reports the Daily Record.

Morrissey said: "The pension tax paying population is surging. On the one hand, this can be celebrated as a sign of rising incomes among this population, but it's also fair to say that frozen tax thresholds have also played a huge part in dragging more pensioners into taxpaying territory. With the freeze set to stay in place until 2028, we expect to see these numbers continue to swell."

She further explained: "There are things that can be done to help manage these tax liabilities. For a start, up to 25 per cent of your pension can be taken tax free and this can be used alongside taxable income to keep you below an income tax threshold. Retirement income is also more than just about pensions, with ISAs also able to play a key role."

It's important to understand that ISA earnings are not subject to taxation, meaning they can supplement your pension income to help reduce your overall tax liability.

Ms Morrissey also highlighted how pensions can play a crucial role in helping working-age individuals better manage their tax responsibilities. She said: "Paying into a pension reduces your adjusted income and this can reduce the amount of tax you have to pay or even stop you from breaching a threshold that moves you into paying tax at a higher rate.

"This can be especially helpful to those who earn between £100,000 and £125,140 per year who get hit by the stealthy 60 per cent tax trap that erodes your personal allowance."

Through the Triple Lock mechanism, both the New and Basic State Pensions increase annually based on whichever is highest among average yearly earnings growth from May to July, CPI inflation to September, or 2.5 per cent. The policy aims to protect State Pension values from being eroded by rising living costs.

Both the New and Basic State Pensions received a 4.1 per cent increase this April - however, forecasts from the Labour Government predict a 2.5 per cent yearly rise over the next four financial years.

According to these predictions, the full New State Pension is expected to reach £12,578.80 in the 2027/28 financial year - surpassing the Personal Allowance by £78.80. Although the taxable part of the State Pension may seem relatively small - tax is only charged on the amount that exceeds the Personal Allowance - pensioners with extra income sources might end up paying more to cover a tax bill, unless it's automatically taken from private or workplace pensions through PAYE.

Online guidance at GOV.UK on who might need to pay tax on their pension also includes a handy tool to calculate how much tax someone might need to pay, and the different ways this can be done.

The latest State Pension Triple Lock forecasts suggest the following projected annual increases:

• 2025/26 - 4.1%, the forecast was 4%
• 2026/27 - 2.5%
• 2027/28 - 2.5%
• 2028/29 - 2.5%
• 2029/30 - 2.5%

Full New State Pension

• Weekly payment: £230.25
• Four-weekly payment: £921
• Annual amount: £11,973

Full Basic State Pension

• Weekly payment: £176.45
• Four-weekly payment: £705.80
• Annual amount: £9,175

Under a 2.5 per cent increase, the full New State Pension will be worth:

• 2026/27 - £236 per week, £12,227.30 a year
• 2027/28 - £241.90 per week, £12,578.80 a year

Guidance on GOV.UK states: “You pay tax if your total annual income adds up to more than your Personal Allowance. Find out about your Personal Allowance and Income Tax rates.

Your total income could include:

• the State Pension you get - Basic or New State Pension
• Additional State Pension
• a private pension (workplace or personal) - you can take some of this tax-free
• earnings from employment or self-employment
• any taxable benefits you get
• any other income, such as money from investments, property or savings

Before you can check, you will need to know:

• if you have a State Pension or a private pension
• how much State Pension and private pension income you will get this tax year (April 6 to April 5)
• the amount of any other taxable income you’ll get this tax year (for example, from employment or state benefits)

You cannot use this tool if you get:

• any foreign income
• Marriage Allowance
• Blind Person’s Allowance

Use this online tool at GOV.UK to check if you have to pay tax on your pension. The full guide to tax when you get a pension can be found on GOV.UK here.