Scandal of a hidden tax rule that punishes widows on a pension

Scandal of a hidden tax rule that punishes widows on a pension

While the furore over the abolition of the 10p tax rate refuses to die down, a largely forgotten group of pensioners has been hit with losing 30p in each extra pound they earn in income tax. Among the hardest hit by a little-known tax rule, the "age allowance clawback", are widows - and widowers - who "inherit" pensions from their former spouses. In some cases, they can end up paying far more than their combined tax bill as a married pensioner couple, despite having lower earnings as a single person.

Jeanne Brown, who lives near Sheffield, found her tax bill soared after her husband, Alec, died three years ago.

"Between us, we had a little over £30,000 a year in state and occupational pensions - roughly half and half. When he died, I qualified for a widow's pension from British Steel, his former employer, and now my earnings are around £25,000 a year. I am not complaining about poverty as I know I am well-off compared with many and I do believe in paying taxes, but I think it is wrong that I now pay more income tax on this smaller sum coming in to the household than would have happened if Alec had been alive," says Jeanne, 76, who taught French and Spanish in secondary schools. She took early retirement under a special scheme in the mid 1980s when she was 55.

The problem that has hit Jeanne, and many others in the 65-plus age group, is down to an HM Revenue ruling called the "age allowance clawback". Once a taxpayer reaches 65, their.....continued below

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personal income tax allowance goes up substantially. In this 2008-09 tax year, someone under 65 can earn £5,435 a year before paying income tax.

But a person aged 65 to 74 is allowed £9,030 before income tax becomes due. It rises again to £9,180 a year for those aged 75 or over. This gives a substantial earnings boost to older people. An under-65, earning £15,000, pays £1,913 in income tax - but someone aged 70 would only pay £1,194 while an 80-year-old would get a £1,164 bill.

But the age allowance clawback is the catch to this Treasury generosity. And it's as financially painful as it sounds. Once someone over 65 earns £21,800, the extra tax allowance they get - either £9,030 or £9,180 - is taken back on the basis of £1 removed for every extra £2 they earn from pensions or savings. Someone on £22,800 would be £1,000 over the "age-related allowance limit" so they would lose £500 from their allowance. The two-for-one erosion continues until 65- to 74-year-olds earn £28,990 when they lose all the extra age-related tax benefit.

"The maths of all this mean that for every extra pound someone like Jeanne has coming in, she pays 30p in income tax," says John Whiting, tax expert at PricewaterhouseCoopers.

"Whatever the rights and wrongs about helping people in retirement with extra tax allowances, this causes sheer confusion. Those on the receiving end like Jeanne cannot see why they should be taxed more heavily on each extra £1 than most under 65s. And to make matters worse, this requires a lot of Revenue administrative effort with the chance to get it wrong. But above all, it punishes widowhood - it's a stark unfairness," he adds.

Here's an example of how two people can pay less tax than one.