Wednesday, 11 April 2012


Imposing the Pay As You Earn (PAYE) tax collection system on the state pension – an Easter idea floated by the Treasury – could  be a disaster.

Not just because it would combine the communication and administrative talents of DWP and HMRC – a toxic mix if every there was one.

But because PAYE is least able to cope when income changes during the tax year and when there is more than one source of income.

Which is exactly what happens at retirement and after.

PAYE is a way of collecting tax not assessing it. That is why every year millions of tax codes are wrong, too little or too much tax is deducted, and HM Revenue & Customs has to write to those taxpayers asking them to send more money or enclosing a refund cheque - or sometimes both.

PAYE works well when people have a single smooth regular income. That is not the common experience in retirement. Eight out of ten older taxpayers have multiple sources of income.(1)

There is no longer one retirement age. People move from full time work to part-time, pensions kick in at different ages, and the state pension arrives at a date that is set to rise to 68 or beyond.

As retirement takes hold some taxpayers move to incomes too low to pay tax. Others who have not worked for some time will find the state pension is their first taxable source of income for years. Many will acquire a second, third or fourth source of income as pensions kick in and perhaps part-time work is started. 

All those changes may happen over several tax years. And they are exactly the conditions which baffle PAYE and lead to under- and over-payments of tax followed by recovery or repayment, often years later.

It may not matter too much to someone in a well paid job if they suddenly get a demand for hundreds of pounds tax. It certainly will matter to someone on an income of £12,000 a year.

MPs reported in February 2010 that an estimated 1.5 million older people had overpaid £250 million of tax on their personal and company pensions and half a million had underpaid £100 million. (1)

Why extend those problems to the state pension as well?