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Another tax loophole could hit pensioners

Holly Thomas, finance journalist

Pensioners who have worked and saved hard for their retirement fund could find themselves paying a rate of 30 per cent tax on their income in another depressing reminder of how unfair our pensions system is, writes Holly Thomas

Thanks to a little-known tax rule known as the "age allowance clawback" or "age allowance trap", HM Revenue & Customs can take more of your cash in retirement when you hit 65 if your income is between £21,800 and £27,800.

In this 2008-09 tax year, someone under 65 can earn £6,035 - up from £5,435 following yesterday's announcement from Chancellor Alistair Darling - a year before paying income tax.

But a person aged 65 to 74 is allowed £9,030 before income tax becomes due rising again to £9,180 a year for those aged 75 or over.

Great news - on the surface. Dig a little deeper into the workings of the age allowance clawback and find that this figure is cut significantly.

Once someone over 65 earns £21,800, they lose the extra tax allowance they get at the rate of £1 for every extra £2 they earn from pensions - state as well as private, and income from savings.

Using this formula, someone with an annual income of £22,000 is £200 over the £21,800 threshold, and so they would lose £100 of their allowance, bringing it down in real terms down to £8,930 from £9,030.

So the effective rate of tax on that extra income works out as 30 per cent, or 30p in the £1.

As if this news wasn't bad enough, there is another twist in the tale.

You might be thinking you will escape this tax band, since in reality not everyone is fortunate to have secured an income of this level. But think about this.

What happens when a spouse passes away and the remaining partner inherits a proportion of their pension?

The raw truth is that if the additional income pushes the living partner into this income band of more than £21,800, they will be forced to pay tax at the dreaded 30 per cent rate.

The new tax bill could end up being more than their combined tax bill as a married pensioner couple, despite having lower earnings as a single person.

Coping with the loss of a loved one can be difficult enough to deal with, without seeing more of your hard-earned cash going into Government coffers.

Unfortunately this rule looks set to stay, and if you fall within this income band then you will be faced with this higher bill.

But in the same way I would urge workers to check their tax code, so should pensioners. I have heard many readers complaining that the Revenue has clawed back money they shouldn't have because incorrect assumptions were made about their income.

You cannot take for granted that you are on the correct tax code and so it is up to individuals to do their own dirty work and check the Revenue has their correct earnings on file.

* Holly Thomas is the deputy personal finance editor of the Daily Express and Sunday Express. Her opinions are her own and for general information only. Always seek independent financial advice.

* Paul Lewis is away

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