The government's expected changes to state pension taxation could create unfair 'cliff edges' for pensioners with small amounts of private pension income, while becoming increasingly expensive for the Treasury, LCP has warned.

In Wednesday's Budget, Chancellor, John Healey, is expected to outline how the government intends to ensure that pensioners whose only income is the new state pension do not pay income tax from April 2027.

The commitment, originally announced by Rachel Reeves in the 2025 Budget, is intended to address the impact of the new state pension exceeding the frozen personal allowance for the first time in April 2027.

However, LCP warned that emerging details of the proposed arrangements, which could introduce an additional tax-free allowance for pensioners relying solely on the new state pension, risk creating administrative complications and high long-term costs.

Without intervention, pensioners receiving only the full new state pension could face an annual income tax bill of around £93.

LCP warned that the gap between the state pension and the personal allowance was likely to widen in subsequent years, increasing the cost of the proposed exemption.

It argued that the growing cost could make the policy increasingly difficult for future governments to withdraw, as doing so could leave lower-income pensioners facing additional tax bills.

LCP also raised concerns about the potential creation of a 'cliff edge' if the additional allowance was restricted to those whose income matched the full new state pension.

Under such an arrangement, LCP suggested that pensioners receiving even £1 of additional taxable income could lose the protection entirely, potentially leaving them more than £200 worse off annually by 2029/30, unless a tapering mechanism was introduced.

The consultancy also questioned how the proposed arrangements would operate for pensioners receiving modest state pension payments alongside small private pensions.

It noted that the changes could add administrative burdens if individuals had to pay income tax through PAYE before claiming rebates.

LCP partner, Steve Webb, said: "This scheme is being developed because the repeated freezing of the personal allowance has dragged more and more pensioners into the tax net.

"But the proposed solution looks messy and increasingly expensive.

"The gap between the new state pension and the tax threshold is set to grow every year, which will make the policy hard to switch off. But if it continues, the cost will grow and grow.

"And if the extra allowance is available only to those on a low income, there could be a growing 'cliff edge' problem where those with very small amounts of private income lose the whole allowance and end up worse off than those with nothing."

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