The Treasury is considering proposals that would see income tax deducted from the state pension before it is paid out, in a potential major reform that would shift pension payments towards a PAYE-style system, according to reports suggesting a change in how retirement income is processed in the UK.
Proposed Change To Pension Tax Collection
Under the proposals being examined, tax could be deducted at source by the Department for Work and Pensions before pension payments reach recipients. This would represent a shift from the current system, where pensioners receive their full state pension and any tax due is collected separately through the tax system based on total annual income.
The suggested model would bring pension income closer in line with PAYE arrangements used for employment income, where tax is automatically deducted before payment.
Link To Personal Allowance Threshold
The discussions come as forecasts suggest the full state pension could rise above the £12,570 personal allowance during the 2027 to 2028 tax year. If this threshold is exceeded, part of the state pension could become taxable, increasing pressure on how payments are administered and taxed.
One option under consideration includes applying a default 20% deduction at source, with adjustments made later depending on an individual’s total tax position at the end of the tax year.
Possible Administrative Changes
Reports also suggest that implementation could involve outsourcing parts of the process to private sector providers, reflecting the complexity of integrating tax deductions directly into pension payment systems.
Such a change would require closer coordination between HMRC and the Department for Work and Pensions, particularly in reconciling income data and tax liabilities.
Government Response
A government spokesperson said there has been no change to the tax treatment of the state pension. They added that the government routinely undertakes research to better understand pensioners’ experiences with the tax system, without confirming any specific policy proposals or timelines.
Wider Policy Context
The discussions form part of a broader review of how rising pension values interact with existing tax thresholds. Any move to tax the state pension at source would represent a significant shift in the administration of retirement income, with potential implications for millions of pensioners across the UK.
