The thorny question of the frozen personal tax allowance

Should they win the 4 July general election, the Conservatives have pledged to ensure that retirees do not pay income tax on the state pension, a move some have dubbed the “quadruple lock” – increasing the personal allowance in line with the state pension, but for retirees only.

The proposal is very much open to criticism, but the problem it tries to address is real and entirely of the Conservatives’ own making. It dates back to when Rishi Sunak was chancellor during the pandemic and froze all income tax thresholds, including the personal allowance. This was a tax hike by stealth; arguably, raising income tax rates would have created fewer distortions in the system.

One current distortion is that while the personal allowance is frozen at £12,570 and due to remain so until 2027-28, the state pension keeps going up as mandated by the triple lock – meaning it rises every year in line with wage growth, inflation or 2.5 per cent (whichever figure is highest). It increased by 8.5 per cent in April and currently stands at £11,502.40 a year. With both Labour and the Conservatives pledging to keep the triple lock, retirees will soon pay back a portion of the state pension in income tax.

Quilter estimates that this could materialise in as little as two years. The issue is not just the plain oddity of returning a public benefit in tax, either. “Simply from an administrative point of view this would prove difficult for HMRC,” says Kirsty Anderson, retirement specialist at Quilter. Let’s not forget that the tax office is already struggling with its existing workload.

The Conservatives’ proposal would fix this problem but create others, making the system more complicated and indiscriminately favouring retirees, including those who have other income on top of the state pension. “Increasing the personal allowance just for pensioners may be popular with pensioners, but the rest of the tax paying public may feel that… it further increases intergenerational inequality,” Anderson argues. 

Tom Selby, director of public policy at AJ Bell, deems the proposal “a fairly naked grab for pensioner votes”. “Beyond pure election tactics, it is hard to think of a good reason to increase the personal allowance for pensioners alone,” he adds.

With the Conservatives so far behind in the polls, it is more interesting to ponder Labour’s position. Keir Starmer and shadow chancellor Rachel Reeves have made it clear that while they would like to unfreeze the allowances, they don’t think the country can afford it. But the state pension tax conundrum will not go ignored forever. “It seems unlikely if Labour were to get in they would not be forced to act in some way,” Anderson says.

There is no obvious solution. Reforming the triple lock is a political nightmare that all parties seem keen to avoid. Increasing the personal allowance in line with inflation for everyone looks like the sensible approach, but it would be anything but cheap and would possibly need to be compensated for by an increase to income tax rates.

This is just an example of the tough choices Labour will have to navigate if it does win the election. The party has ruled out future tax increases on a series of taxes, including income tax. But as Helen Miller, deputy director of the Institute for Fiscal Studies, recently argued in the Financial Times, it should refrain from making promises it may come to regret.