Pensioners hit with £8bn tax bill after government freezes allowances
Pensioners paid some £8bn in extra tax last year after a freeze on personal allowances dragged people into higher bands, new figures have revealed.
The amount of tax paid by people in retirement climbed from £21.1bn to £29.8bn, an increase of over 40 per cent in just two years, according to the latest pension participation figures from HMRC.
Industry figures blamed the rise on so-called fiscal drag, where people have been pulled into higher tax bands as thresholds and personal allowances remain frozen.
Steve Webb, partner at LCP and former pensions minister, said: “The constant freezing of tax thresholds and allowances has dragged millions more people into paying higher rates of income tax. The flip side of this is that when they pay into a pension they get more tax relief, leading the cost of tax relief to soar.
“But frozen personal allowances mean that the number of pensioners paying income tax has also written steeply, and the tax bill on pensioners is up dramatically. In all the discussion about fairness between generations it is important to remember that pensioners are also paying growing amounts back to the exchequer.”
The number of higher rate taxpayers reached 6.6m in the last financial year, which has driven up the cost of tax relief on pensions when they pay into a pension. The cost of income tax relief on pensions jumped from £47.8bn in the 2023/24 tax year to £60.4bn in 2024/25, HMRC said.
Webb said that while the government may be tempted to slash tax relief to reduce this cost, doing so is “very difficult halfway through a Parliament”.
“Any change would be complex and technical and could take years to implement. It would deliver little money this side of the next election but would be hugely politically unpopular. The Government may well conclude that it simply has to live with the rising cost of tax relief for now,” he said.
Auto enrolment freeze
Pension participation in the UK remained high last year as the earnings threshold to qualify for auto enrolment remains frozen.
In the UK, employees who are over 22 and under state pension age qualify for eligibility upon earning £10,000 a year. The trigger has remained frozen since the 2014/15 tax year despite both the general and minimum wage increasing.
Roughly 90 per cent of eligible employees saved into a workplace pension in 2025, representing 22.6m eligible people opting to save into a pension pot, according to the latest figures from the Department of Work and Pensions.
This is a 0.6m uptick compared to 2024.
Despite more people qualifying for auto enrolment, some groups continued to have a persistent participation gap.
Around 45 per cent of eligible employees who work for a micro employer, those with less than five employees, in the private sector are not saving into a workplace pension.
Industry figures have also raised the alarm on the self-employed, who do not automatically qualify, and those earning under the threshold are not saving enough or at all, putting them at risk of retirement poverty.
While the department initially pinned the lack of engagement with the pandemic and cost of living crisis, the decision not to save has persisted, with the opt out rate climbing to 12 per cent last year.
Rebecca Williams, financial planning divisional lead at Rathbones, said: “It’s notable that opt-out rates have edged higher. Cost-of-living pressures continue to squeeze household finances, making long-term saving harder for some people to prioritise.
“Meanwhile, lower participation among some groups and employees working for the smallest businesses shows there is still work to do to make retirement saving truly universal.”