Why retired people keep getting tax bills

There is a particular kind of letter that lands on a retired person’s doormat and makes no sense to them at all. They have not worked for years. They have no savings to speak of. Nothing about their life has changed. And yet HM Revenue & Customs has written to say they owe several hundred pounds of income tax — again — as it did last year, and the year before.

The letter is usually right. That is the uncomfortable part. What is almost always wrong is the assumption behind the confusion: that because nobody is paying you a wage, and because nobody sent you a tax return, there is nothing to pay tax on.

This guide sets out the machinery that produces those bills: the two State Pension systems and how each is taxed, what deferring a State Pension does to a tax position for the rest of someone’s life, how PAYE codes try — and routinely fail — to collect the tax, which DWP payments are taxable, and where the genuine points of challenge lie. It is written for people already receiving these letters, and for the family members trying to work out what they mean.

The State Pension is taxable, but it is paid gross

The State Pension is taxable income. It counts towards your Personal Allowance and your tax bands exactly as a salary would.

But the Department for Work and Pensions does not operate PAYE on it. It pays the full amount into your bank account with nothing deducted. There is no payslip, no tax code and no P60 from DWP, because no tax was taken off.

So the tax is real and still owed. HMRC simply has to collect it from somewhere else. That “somewhere else” is the whole story.

For the 2026-27 tax year the standard Personal Allowance is £12,570. The full new State Pension is £241.30 a week, which is £12,547.60 over a 52-week year.

Those two figures are now roughly £22 apart. Someone on the full new State Pension and nothing else pays no tax — but only just, and only if they have nothing else at all. Add any second pension, annuity, deferral uplift or earnings, and that additional income is taxable from the first pound, because the State Pension has already used up effectively all of the allowance.

That is the structural position. Everything below follows from it.

Old State Pension and new State Pension

Two separate State Pension systems run side by side, and their rules — particularly on deferral — are materially different. The dividing line is the date you reached State Pension age.

Two points in that table do most of the damage in practice.

The old system produces much bigger pensions than people expect. The basic rate is £184.90 a week, but someone contracted in to SERPS across a long working life can have an Additional State Pension worth more than the basic pension itself. A State Pension of £400 or more a week is entirely possible under the old rules and is not evidence of an error. At over £20,000 a year, it is also comfortably above the Personal Allowance on its own.

The deferral rates are not remotely comparable. The old system pays almost 10.4% a year for deferring; the new system about 5.8%. Advice that made arithmetical sense under the old rules can be poor advice under the new ones, and the change took effect in April 2016 — recently enough that some guidance given around that time was given against the wrong rulebook.

The uprating detail that works against deferrers

The triple lock does not apply to all of a State Pension.

For 2026-27, the basic and new State Pensions rose by 4.8% under the triple lock. But Additional State Pension, protected payments and deferral increments rose by 3.8% — the September CPI figure — because those elements are only required to keep pace with prices.

So the part of a pension that came from deferring grows more slowly than the part that did not. The uplift someone bought by giving up years of pension is gently eroding against the headline rate every year: a small point annually, a meaningful one across a retirement.

How HMRC collects the tax: coding out and K codes

If the State Pension is paid gross and you also have a works or personal pension that is on PAYE, HMRC collects the tax on the State Pension through the other pension.

It does this through your tax code. Your Personal Allowance is reduced by the amount of your State Pension, and whatever remains is given against the other pension. That works neatly while the State Pension is smaller than the allowance. It stops working when it is not.

What a K code is

Once your State Pension exceeds your Personal Allowance, there is no allowance left to give. The adjustment goes negative, and HMRC issues a K code.

A K code works the opposite way to a normal code. Instead of exempting income, it adds notional income to the pension it is applied to, so that enough tax comes off to cover the untaxed State Pension as well. A code of K1042 adds £10,430 a year of notional pay to whatever that pension actually pays.

A K code on a modest pension is not an error and not a penalty. It is the system working as designed.

The 50% limit: where the design breaks

The PAYE regulations contain a protection: a payer cannot deduct more than 50% of a payment in tax, whatever the code says. It exists so that a K code cannot swallow someone’s entire pension.

It also means that when the tax owed exceeds half of the small pension, the small pension cannot carry it. The provider deducts the 50% maximum, the rest goes uncollected, and HMRC picks up the shortfall after the end of the tax year.

That shortfall is the letter on the doormat. Because the underlying position repeats every year, so does the letter.

A worked illustration

These are illustrative figures for 2026-27 in England — not anyone’s actual circumstances, and not advice. Suppose someone has a State Pension of £23,000 a year, paid gross, and a small works pension of £2,240 a year on PAYE.

All £2,534 has to come from the £2,240 pension, because it is the only source on PAYE. Even a 100% deduction could not manage it. With the 50% limit, the most it can give up is £1,120, leaving £1,414 to be billed separately — every year the shape of the income stays the same.

The two-thirds rule

There is a useful piece of arithmetic buried in this, because it tells you immediately whether someone is structurally stuck.

In the illustration, the State Pension exceeds the allowance by £10,430. Two-thirds of that is £6,953. The second pension is £2,240. It was never going to be enough, and no amount of correspondence about tax codes will change that.

This separates two quite different problems. If the second pension is above that threshold, a recurring bill usually means the code is wrong, and it can be fixed. If it is below, the code is probably right and the bill is structural: the honest aim is to make collection accurate and predictable, not to expect the bill to go away.

What deferring does, and why it is permanent

Deferring the State Pension means not claiming it at State Pension age, in exchange for a higher weekly amount later — just under 10.4% a year under the old system, about 5.8% under the new.

On its face it is a bet about longevity. Ignoring tax, it takes roughly ten years of the higher pension to recover what was given up under the old rules, and roughly seventeen under the new ones. The tax consequences are where deferral does something people are rarely warned about.

It permanently raises the gross figure, and the Personal Allowance does not move with it. The allowance is a fixed cash amount, not a percentage. So the whole of any uplift sits above the allowance and is taxed in full. A pension of £14,000 has £1,430 exposed to tax. Raise it to £23,000 and £10,430 is exposed. The gross rose by 64%; the taxable slice rose more than sevenfold.

It can push the State Pension past what a modest second pension can carry. This is the decisive effect. Before deferral, the second pension may well have absorbed the tax through its code, and nothing would ever have been billed separately. After deferral, the same pension fails the two-thirds test, the 50% limit bites, and a shortfall falls out every year for the rest of the person’s life.

It is irreversible. A deferred pension cannot be un-deferred. The higher rate is the entitlement now.

It can cross other thresholds. Total income above £35,000 now triggers the Winter Fuel Payment charge, described below, and there is no taper.

None of this makes deferral wrong. For someone with a long life expectancy, no immediate need for the income, and a second pension large enough to carry the coding, it can be a sound decision. The failure is deferral recommended on the uplift percentage alone, without modelling what the resulting gross pension does to the person’s tax collection for the next twenty-five years.

If a lump sum was taken (old system only)

Under the old rules, deferring for at least twelve months allowed the deferred pension to be taken as a lump sum instead, with interest at 2% above Bank of England base rate. That lump sum has its own, unusually favourable, tax rule:

• It is taxed at the highest main rate you already pay on your other income, ignoring the lump sum itself.
• It therefore cannot push you into a higher tax band. A basic-rate taxpayer pays 20% on the whole lump sum, however large.
• If your other income is below the Personal Allowance, no tax is due on it at all.
• For this purpose only, savings and dividend income are treated like any other income.

The legislation is sections 7 to 10 of the Finance (No. 2) Act 2005.

The rule is misunderstood in both directions. People who took a lump sum sometimes believe they were overtaxed when they were not; people who did not take one sometimes find calculations that seem to assume they did. Establishing which option was actually taken — the higher weekly pension or the lump sum — is worth pinning down early, because a DWP deferral letter typically offers both and settles nothing by itself.

Simple Assessment: the PA302

When the shortfall falls out, HMRC does not usually issue a tax return. It issues a Simple Assessment, on a form headed PA302.

Simple Assessment is designed for straightforward affairs — typically State Pension, other pensions, taxable benefits, and up to £10,000 of untaxed income such as bank interest. HMRC calculates the tax itself from information it already holds from DWP, pension providers and banks, and sends you the calculation.

What matters in practice:

• It is a demand, not a proposal. Ignoring it does not make it lapse.
• You have 60 days to query it if the figures look wrong or something is missing. That window is short, and it is the main protection you have.
• Payment is normally due by 31 January after the end of the tax year, or within three months of the date of the letter if that is later.
• It is not a tax return. Receiving one does not put you in Self Assessment, and it does not mean you have done anything wrong.
• The ordinary time limit for assessing is four years from the end of the tax year (section 34, Taxes Management Act 1970), extended to six years for carelessness and twenty for deliberate conduct.

It is common for several years to arrive at once. A household that has heard nothing for years can receive assessments for four or five tax years in the same period, each modest on its own, together feeling impossible. Each year still has to be checked on its own facts. Arriving together is not by itself a ground of challenge — but it does suggest the underlying coding problem was never fixed, and fixing it is the only thing that stops the sequence.

Which DWP payments are taxable

Much confusion comes from the assumption that “benefits are not taxed”. Some are, some are not, and the split follows no obvious logic.

The one most often misread in a pensioner household is Attendance Allowance. It can be a substantial sum arriving regularly from DWP, and it is entirely tax-free. It should never appear in a tax calculation; if it does, that is an error worth raising.

The Winter Fuel Payment charge

From 2025-26, the Winter Fuel Payment carries an income tax charge where the recipient’s total income exceeds £35,000.

• There is no taper. Above £35,000, the whole payment is recovered.
• Within PAYE, HMRC collects it through the tax code: the 2025-26 payment is being recovered through the 2026-27 code, at roughly £17 a month for a £200 payment.
• People in Self Assessment pay it through their return instead.
• It is possible to opt out of receiving the payment rather than repay it.

Because the charge turns on total income, a deferred State Pension is exactly the kind of thing that tips a household over the line.

The Marriage Allowance trap in retirement

Marriage Allowance lets a spouse or civil partner whose income is below the Personal Allowance transfer £1,260 of it to the other, reducing the recipient’s tax by up to £252 a year.

It is a sensible election when one partner genuinely has unused allowance. It becomes quietly harmful when that stops being true — and in retirement, it often stops being true without anyone noticing.

The sequence is simple. A couple elects when one of them has little or no income. Years pass. The State Pension rises every April. Eventually the transferring partner’s own State Pension exceeds their reduced allowance, and they become a taxpayer themselves.

From then on the election costs the transferring partner 20% of £1,260 — £252 — while saving the recipient the same £252. At best the couple is exactly where it started. And the election does not stop by itself: it renews every year until someone cancels it.

Three points about cancelling run against intuition:

1. The person who made the claim must cancel it. Unless the relationship has ended, the recipient cannot.
2. Cancelling because of a change of income is not backdated. The allowance runs to the end of the current tax year, 5 April. The years in which it worked against you cannot be recovered.
3. Leaving it off a tax return does not cancel it. It has to be cancelled actively, online or by phone.

So this has to be spotted going forward, not after the fact. In a household where both State Pensions have grown past the allowance, checking whether an old election is still running is one of the few genuinely available improvements — and it only helps from the next tax year on.

When a bill is genuinely wrong

Most recurring pensioner assessments are arithmetically correct. Not all of them. These are the grounds worth examining.

The State Pension figure itself. Ask DWP for a written State Pension statement and compare it with the figure HMRC has used. They should reconcile. If HMRC is using an estimate or a superseded figure, that is a correctable error — and the evidence is the DWP statement, not a bank statement.

Tax-free payments treated as taxable. Attendance Allowance, PIP and the other items in the right-hand column above should not appear in a calculation.

Income attributed to the wrong spouse. A pension paid into one spouse’s bank account does not move the tax point. The income belongs to the person entitled to it — the name and National Insurance number on the P60 decide whose income it is, not the account it lands in. This is a common source of confusion in long marriages, and it usually resolves against the intuitive answer.

Double collection. Where an earlier year’s underpayment is being collected through the tax code and also sits inside a Time to Pay arrangement, the same money can be collected twice. This has to be checked deliberately; it does not surface on its own.

Employer or provider error. Where a pension payer or employer operated the wrong code — on a payment made after someone left, for instance — the resulting underpayment may be the payer’s responsibility rather than the individual’s. This is a narrower point than ESC A19, and a more concrete one.

Time limits. An assessment outside the four-year window in section 34 TMA 1970 needs a statutory basis to stand. Check the issue date on every assessment rather than assuming.

ESC A19, realistically. Extra-Statutory Concession A19 allows HMRC to give up arrears where it failed to make proper and timely use of information it held, told you about the tax more than twelve months after the end of the tax year in which it received that information, and it was reasonable for you to believe your affairs were in order.

It is a concession, not a right, and HMRC applies it narrowly. A recurring shortfall caused by the shape of someone’s income is usually not an HMRC delay at all — it is the system doing what it was designed to do. Where the real cause is a large gross State Pension meeting a small second pension, A19 is not the answer, and presenting it as one sets an expectation that will not survive contact with HMRC.

What to gather first

The position cannot be assessed without the documents. In rough order of usefulness:

• A written State Pension statement from DWP for each person, showing the current weekly rate and the date entitlement began. This one document resolves more questions than any other.
• Any DWP deferral correspondence, including the letter offering a higher pension or a lump sum — and evidence of which was actually taken.
• Every P60 from every pension provider and annuity, for every year in question.
• Every coding notice (P2) and every Simple Assessment (PA302), including the calculation pages, not only the page with the amount on it.
• Any Time to Pay arrangement already in place, with its schedule.
• Confirmation of any Marriage Allowance election, and which spouse made it.
• Details of any tax-free DWP payments, Attendance Allowance in particular, so they can be excluded rather than assumed.

The pages people skip are the ones that matter. The front of a PA302 tells you the amount. The calculation page, and the notes page of a coding notice, tell you whether it is right.

The honest summary

For a retired household with a large State Pension and a small second pension, most of the tax is genuinely due, and the annual letter is the system collecting it the only way it can. Anyone promising that the bills will simply disappear is not describing how the rules work.

What can usually be improved is different, and it is not nothing:

• the State Pension figure HMRC holds matching DWP’s own statement
• tax-free payments kept out of the calculation
• an old Marriage Allowance election that now works against the household, stopped going forward
• confirmation that nothing is being collected twice
• codes set correctly, so the shortfall is as small and predictable as the arithmetic allows
• any employer or provider error, and any year outside the statutory time limits, examined

And for anyone still making the decision: do not defer a State Pension on the uplift percentage alone. Ask what the resulting gross pension will be, whether the second pension is big enough to carry the tax under the two-thirds rule, and what the position will look like in ten years. The old rules paid just under 10.4% a year for deferring; the new rules pay about 5.8%. Advice suited to one is often wrong for the other, and the tax position it creates lasts for the rest of your life.

Sources

• Income Tax rates and Personal Allowances — GOV.UK
• Benefit and pension rates 2026 to 2027 — GOV.UK
• Deferring your State Pension — GOV.UK
• Taxable and tax-free state benefits — GOV.UK
• Understand your Simple Assessment tax bill — GOV.UK
• EIM75750: social security pension lump sums — HMRC Employment Income Manual
• Finance (No. 2) Act 2005, sections 7 to 10 — legislation.gov.uk
• PAYE11095: K codes — HMRC PAYE Manual
• PAYE76055: K codes and State Pensions — HMRC PAYE Manual
• Marriage Allowance and if your circumstances change — GOV.UK
• Winter Fuel Payment: if your income is over £35,000 — GOV.UK
• If HMRC did not act on information they were given — GOV.UK
• EM3214: time limits, sections 34 and 36 TMA 1970 — HMRC Enquiry Manual
• Benefits Uprating 2026/27 — House of Commons Library