How does Rest Less make money
We make money through advertising and commission from affiliate links, which enable us to offer Rest Less as a free service to our users. The content on this page may use affiliate links, which track traffic from our website to a third party provider and enable us to receive a commission or payment from any traffic we refer.
* Affiliate links on this page have an * next to them. We place enormous importance on our editorial independence and the integrity of our content which means that we will never change how we write about something as a result of an affiliate link.
Speculation is growing ahead of the Budget that Chancellor John Healey could increase the personal allowance, potentially allowing people to receive more income before they start paying income tax.
If you’re retired, this could make a difference to how much of your pension income you get to keep. It could also benefit people who are still working, leaving them with more take-home pay which they could choose to put towards their pension or use to meet rising household costs.
The personal allowance has been frozen at £12,570 since 2021/22 and is currently due to remain at that level until April 2031. As wages and other taxable incomes rise, this can result in more people being pulled into paying tax or into higher tax bands, a phenomenon known as ‘fiscal drag’.
The issue is particularly relevant to retirees. The full new State Pension is £12,547.60 a year in 2026/27, just £22.40 below the current personal allowance.
Here, we look at what an increase in the personal allowance could mean for your pension and tax bill.
How does the personal allowance work?
The personal allowance is the amount of income you can receive each tax year before you start paying Income Tax. It is currently £12,570 and is due to remain frozen at this level until April 2031.
The allowance applies to your total taxable income, rather than being available separately for each source of income. This could include your State Pension, workplace or personal pensions, earnings and taxable savings interest.
In England, Wales and Northern Ireland, taxable income above the personal allowance is generally taxed at 20% up to £50,270, with the 40% higher rate applying above that level. Different income tax rates and thresholds apply in Scotland.
If your adjusted net income is above £100,000, your personal allowance is reduced by £1 for every £2 of income above this threshold. Once your income reaches £125,140, the allowance is reduced to zero.
The freeze has increased the number of people paying higher-rate tax. HMRC estimates that 7.7 million people will be higher-rate taxpayers in 2026/27, around 1.9 million more than in the 2023/24 tax year.
What a higher personal allowance could mean for you
A higher personal allowance means you can receive more money before you start paying income tax, enabling you to keep more of your pension income or wages if you’re still working.
Someone with £12,570 of taxable pension income currently pays no income tax. If the personal allowance rose to £13,570, they could receive an additional £1,000 before tax became payable.
So, for example, a pensioner with £15,000 of taxable income would currently pay £486 in income tax (£15,000 – £12,570 = £2,430 × 20%). If the allowance rose to £13,570, their tax bill would fall to £286, representing a £200 saving.
What if your State Pension is close to the personal allowance?
The personal allowance is currently £12,570, while the full new State Pension is £12,547.60 a year in 2026/27.
That means someone receiving the full new State Pension and no other taxable income is currently just £22.40 below the allowance.
If the State Pension rises above the allowance, as is currently expected, it doesn’t mean the whole State Pension becomes taxable. Only the amount above the allowance would be taxable, assuming the person has no other taxable income.
However, the Prime Minister Andy Burnham has pledged that low-income pensioners will not pay any income tax on their state pension during this parliament. Maike Currie, VP Personal Finance at PensionBee, said: “As the State Pension moves closer to the personal allowance, it makes little sense to give pensioners an increase with one hand only to claw some of it back in income tax with the other. The commitment that those on the lowest incomes will not be dragged into paying tax is therefore important.”
Could making pension contributions help reduce your tax bill?
If you’re still working, increasing your pension contributions could potentially reduce the amount of income on which you pay tax, depending on how your pension scheme operates.
Contributions to a personal or workplace pension are generally eligible for tax relief, while contributions made through salary sacrifice can reduce your taxable pay. This can be especially helpful if you’re close to a tax threshold.
Ms Currie said: “Salary sacrifice, where offered, can reduce taxable pay and National Insurance – a benefit that is already set to become less generous. From April 2029, only the first £2,000 a year of pension contributions made through salary sacrifice will remain exempt from National Insurance. Any employee contributions above that will attract both employee and employer NI.”
What should you do now?
The Budget is just a few weeks away, and it’s rarely a good idea to change your pension arrangements based on speculation about what the Chancellor might announce.
However, it could be worth checking how much taxable income you currently receive, which tax band you fall into and how much income tax you pay.
If you’re still working, you could also check whether you’re making the most of the pension tax relief available to you, particularly if you’re close to a tax threshold.
If the personal allowance is increased, the amount you could potentially save will depend on your income and how the change is structured. It may therefore be worth reviewing your position once the Budget is confirmed on 28 October.
Rest Less Money is on Instagram. Check out our account and give us a follow @rest_less_uk_money for all the latest Money News, updated daily.
Join the discussion
Read our full commenting terms and guidelines