Pensioners' tax should be simplified, OTS says

Taxation of pensioners has long been a problematical area both for individuals and HM Revenue & Customs (HMRC). However, the system is in the process of being overhauled, which has already led to some improvements. More changes should be on the way if recommendations made by the Office of Tax Simplification (OTS) are acted upon. Its interim report identifying areas for immediate action was issued in 2012 and its final report was published in time for the 2013 Budget.

The OTS says that the most effective simplification would be to exempt the state pension from tax, but it accepts that it would be a step too far, particularly for public finance. Therefore, it recommends two broad areas for simplification: legislative changes to remove complexity in the system and administrative improvements.

Recommendations

In relation to policy, the OTS recommends that the 10% tax rate on dividends should be removed as it is not understood. In its place, the OTS comments that incentives on individual savings accounts could be improved as they are already comprehended. It also suggests removing or simplifying the married couples' allowance, which only applies to people born before April 1935, and abolishing the blind person's allowance. It believes that the funds from the cuts could be better used in providing direct grants and support to blind people.

The report makes a number of recommendations for improvements in the administrative system, including:

  • the Department for Work and Pensions (DWP) should issue a P60-type form each April indicating the amount of taxable income from state pension and other benefits to which the pensioner was entitled in the previous year;
  • HMRC should introduce a single, composite PAYE coding notice that would aggregate the various individual codes for each source of income under PAYE and would provide a reconciliation with the individual's personal allowance; and
  • improvements should be made to the form that banks and building societies issue, which enables non-taxpayers to receive the interest on their savings free of tax.

Progress already

Since the interim report was published some changes have been made to the system, in particular with regard to communications. A major improvement is that the DWP is now feeding data on all new pension claims and changes to pension rates to HMRC electronically. The OTS reviews these changes in its report and puts forward a number of further improvements.