'Granny tax' Q&A: Pensioner allowances explained

The change in allowances will save the Treasury millions of pounds

To Chancellor George Osborne it is a simplification in a complex tax system. To its critics, it is a "granny tax". But what does it mean for you?

The change in age-related personal allowances - the amount of income that is tax-free - will save the government £1bn by 2015.

It will mean that millions of people will not be as protected from tax as they expected to be - which will affect their financial planning as they approach retirement.

So what is my personal allowance?

A personal allowance is the first chunk of income that anyone earns that is tax-free.

Any amount earned above this level is subject to tax at various bands.

And my tax-free income depends on my age?

Correct. There has been a different level of personal allowance for pensioners since Winston Churchill introduced it in the 1920s.

So, if you are aged under 65, the first £8,105 of your income is tax-free. This will change to the first £9,440 in the 2013-14 financial year.

If you are aged 65 to 74, then you get a bit more of an allowance. The first £10,500 is tax-free.

If you are aged 75 and over, then the personal allowance is £10,660.

However, this extra allowance is gradually withdrawn from those pensioners with a taxable income of between about £24,000 and about £29,000. So pensioners who earn more than this do not get the extra benefit.

And anyone with an income of more than £100,000 has all their personal allowance gradually withdrawn, regardless of age.

So what will change?

Mr Osborne announced two significant measures in the Budget on 2012.

The first is that, while the personal allowance for the under 65s will go up again in April 2013, the allowance for those aged 65 and over will be frozen at the same levels as 2012-13.

Secondly, anyone who turns 65 after 5 April, 2013, will not get an extra allowance at all. They will benefit from the same personal allowance as the under-65s.

Who is most affected?

Most significantly, those who hit 65 just after April 2013 will not get the tax-free allowance they might have expected in subsequent years.

They will get a personal allowance of £9,440. In contrast, someone who turns 65 just before April 2013 will get a personal allowance of £10,500.

HM Revenue and Customs (HMRC) says this will bring an extra 230,000 into the income tax system. For many, this will mean having to fill out a self-assessment tax form every year.

Pensioners with an income of more than about £30,000 will not be affected at all, because they would not have received the extra allowance anyway. They make up about 10% of all pensioners.

People on the basic state pension and pension credit will not earn them enough to pay income tax, so they will be unaffected too. That is about 50% of pensioners.

That means, it is a "middle-income" range of 40% of pensioners who will not get what they might have expected from the tax system.

Their income is likely to be made up of state and workplace or private pensions, as well as some money in savings accounts.

How much will they miss out on?

Figures from HMRC show that, taking inflation into account, this will leave 4.41 million people worse off than they would have expected, by an average of £83 a year in 2013-14.

People due to turn 65 after 5 April 2013 will miss out on an average of £285 compared with what they expected in 2013-14. The biggest loss is £322 that year.

However, nobody will have cash taken away from them that they had already received.

Haven't these people been doing well from government policies?

This is a political argument that has been doing the rounds.

Many pensioners have been spared some potential cuts during the government's austerity drive.

For example, they still receive help with their fuel bills, regardless of their income, and many have benefited from the rising value of their homes.

One thing is certain, they are the subject of the biggest tax raising change announced in the Budget this year.

The move will save the government £360m in 2013-14, rising to £1.25bn a year by 2016-17.