Thank you for subscribing!

The full new state pension is expected to exceed the £12,570 tax-free personal allowance for the first time from April 2027

Older workers who choose to defer their state pension face tax bills of up to £560 that retirees claiming immediately will avoid entirely, thanks to a loophole in Labour's income tax exemption for pensioners.

The policy effectively punishes those who opt to keep working longer, according to former pensions minister Sir Steve Webb.

Former chancellor Rachel Reeves pledged last year that pensioners who rely solely on the state pension would not have to pay income tax.

However, this protection does not extend to people who delay claiming their state pension and receive a higher amount as a result.

Sir Steve, who is now a consultant at LCP, warned this could create a "tax penalty" worth "hundreds of pounds" for older people who decide to keep working.

The issue is expected to become more significant from April 2027, when the full new state pension is set to rise above the £12,570 tax-free personal allowance for the first time.

The full new state pension currently pays £12,547 a year, leaving it just £23 below the personal allowance.

Labour has confirmed the £12,570 tax-free threshold will remain frozen until 2031, while the state pension will continue to rise under the triple lock.

This means the pension is guaranteed to move above the personal allowance from April 2027.

Analysts expect next year's triple lock increase to be determined by wage growth, potentially taking the full new state pension above £13,000 a year.

For someone who claims their state pension immediately, this could ordinarily result in an income tax bill of around £100 a year.

However, Ms Reeves's exemption would protect pensioners relying solely on the state pension from having to pay that charge. The situation is different for people who defer their pension.

Someone who delayed claiming for 12 months before starting to receive their pension from April 2027 could face a tax bill of as much as £560.

By comparison, a pensioner who had not deferred and was receiving the standard state pension could pay no income tax at all under the exemption.

Sir Steve argued that the Government was contradicting its own objectives by discouraging people from remaining in work.

"Deferral can be attractive for some people. If you want to work on, you don't really want to add your state pension to your wages and pay lots of tax," he said.

"But now it turns out there can be a tax disadvantage and, over the next three years, that will cost you hundreds of pounds."

He added: "It seems odd to penalise those who defer and not those who don't. On the whole, the Government wants people to work longer and this is a tax penalty for those who work longer who work and defer taking their pension."

Figures from Royal London show that nearly 42,000 individuals claimed a deferred state pension in 2023-24, with one in four having postponed for five years or more.

Deferral increases the eventual payout by one per cent for every nine weeks delayed, equating to just under 5.8 per cent annually.

Despite the pledge's prominence, analysis from LCP published earlier this year revealed it would protect just 800,000 of Britain's 13.2 million state pensioners, amounting to roughly one in 17.

Those receiving any additional state pension, known as Serps, are ineligible. Around 7.7 million people on the basic state pension are also excluded, along with 1.6 million who either reside overseas or whose income falls below the taxable threshold. A further two million are shut out because they have other sources of taxable income.

A Treasury spokesman defended the approach: "Pensioners whose only income is the full new or basic state pension without any increments will not pay income tax and we are committed to that over this parliament.

"By keeping the triple lock, 12 million pensioners will see their income rise by up to £470 this year, and they continue to benefit from one of the most generous personal allowances in the G7."