Hundreds of thousands of women who count on their marriage tax allowances could be hit with a surprise bill next year.
As many as 750,000 couples of pension age use the marriage allowance to cut their tax bills by sharing part of their income tax allowance.
However, a combination of frozen tax thresholds and rising state pensions mean that many couples could face unexpected demands from HM Revenue & Customs next April because they will no longer be able to benefit fully from the tax break.
Former pensions minister Steve Webb, who is now a partner at actuary and consulting firm Lane Clark & Peacock (LCP), warns it could cause ‘mayhem’ for those who make use of their marriage allowance.
You can earn up to £12,570 before having to start paying tax — known as the personal income tax allowance.
Tax bills: A combination of frozen tax thresholds and rising state pensions mean that many couples could face unexpected demands from HM Revenue & Customs next April
Married couples where one spouse earns below this threshold can share their allowances under a tax break known as the marriage allowance.
If one partner earns at least 10 per cent less than the personal allowance — £11,310 — and the other is a basic-rate taxpayer, the lower earner can hand over 10 per cent of their unused tax allowances at no extra cost.
This shields a larger portion of the couple’s income from taxes.
Until now, anyone receiving the full state pension, currently £10,600 a year, has been able to use the marriage allowance so long as they have no other earnings.
This is because their pension income was more than 10 per cent below the personal allowance threshold.
Those who make use of the marriage allowance can save up to £252. For example, where a retired woman relies entirely on the state pension, she can give her husband an extra allowance of £1,260.
As a basic-rate taxpayer, he will no longer pay 20 per cent tax on this sum — saving £252 a year. Once the wife has opted in to this system, the transfer carries on every year until it is revoked by the couple.
It is typically the wife who has the lower income and therefore she shares her allowance with her husband, who must be a basic-rate taxpayer.
But from next April, a bumper increase in the state pension will mean that many of the women who have relied on this tax break could now face tax bills as a result of it, because their earnings will be too close to the allowance.
The state pension could increase by 8.5 per cent next year under the Government’s ‘triple lock’, after earnings growth rose higher than expected over the summer, according to official data.
The triple lock guarantees that pensioner incomes rise by the highest of inflation, wage growth or 2.5 per cent every year.
If the triple lock is honoured, pensioners on the full new state pension — paid to those who reached pension age after 2016 — are in for a £902.20 boost next year, pushing their annual income up to £11,502.40.
However, to make full use of the allowance, your earnings must be below £11,310.
As many as 750,000 couples of pension age use the marriage allowance to cut their tax bills by sharing part of their income tax allowance
This means many women could find themselves with a tax liability, because they have handed 10 per cent of their allowance to their husband who can benefit but their state pension exceeds 90 per cent of the allowance. They would be taxed on the amount by which they exceed the allowance.
For example, the new state pension could rise to £11,502.40. This is £192.40 over their remaining personal allowance.
They would therefore be liable for £38.50 in tax. Income tax allowances typically rise in line with inflation, but the Government has frozen them — including the personal allowance — until 2028 in a ‘stealth tax’ raid, which is designed to shore up the Treasury’s budget deficit.
Mr Webb says: ‘This is yet another unwelcome by-product of the year-on-year freeze in the value of the tax allowance.
‘We could see marriage allowance mayhem as hundreds of thousands of couples have to decide whether to carry on with this arrangement or cancel it, if low-income pensioners are to avoid being dragged into the tax net. The sooner the freeze on tax allowances comes to an end, the better.’
Couples who are caught in the tax net will be able either to carry on with the marriage allowance, leaving the wife with a small tax bill every year, or they can cancel the marriage allowance, increasing the husband’s tax bill and potentially leaving them worse off overall.
The issue will also affect non-pensioner couples, but in many of working age, there will be a stay-at-home partner who has little or no taxable income, so they do not need to worry about this issue.
Those earning part-time will continue to be able to use the allowance so long as their earnings remain at least 10 per cent below the £12,570 threshold.
But for pensioners, even the lower-income partner may be relatively close to the tax threshold because of the increase in the state pension.
The tax burden on pensioners will grow across the board next year. More than half a million retirees will be dragged over their personal allowance threshold when the state pension rises next April. Any pensioner receiving more than £242 a week will have to pay tax.
Next Wednesday, Chancellor Jeremy Hunt will give his Autumn Statement and announce the rate by which the state pension will increase next year.
Officials warned last month that the Government is looking at plans to cut the rise in the state pension so recipients do not get the full 8.5 per cent they are expecting.
They argue the figures are artificially high and ‘distorted’ by one-off public sector bonuses and wage settlements.
j.beard@dailymail.co.uk
Some links in this article may be affiliate links. If you click on them we may earn a small commission. That helps us fund This Is Money, and keep it free to use. We do not write articles to promote products. We do not allow any commercial relationship to affect our editorial independence.