The state pension could soon be taxed before it is paid out to retirees under fresh Treasury plans.

Chancellor Rachel Reeves is drawing up proposals to hold income tax from the state pension before payments are made.

In what could be one of her last acts before leaving Number 11, the Chancellor is said to be looking at the proposals in collaboration with the Department for Work and Pensions, according to a report in City A.M. 

As it stands, pensioners who have an income exceeding the personal allowance of £12,570 may need to file a tax return and be billed for income tax after they have received the money. 

Many pensioners would likely see the department deducting income tax ahead of the payouts in a similar way to PAYE, the way businesses deduct tax before paying salaries.

The proposals have been floated to deal with the impeding breach of the personal allowance as the annual state pension is expected to rise above £12,570 next April.

Everyone, including retirees, can receive £12,570 in income every year free of tax.

Until now, the full, new state pension has been under that limit as the state pension climbed by 4.8 per cent to £12,547 in April under the triple lock mechanism.

Every April, payments climb by the highest of inflation, wage growth or 2.5 per cent under the golden mechanism that protects pensioners from rising costs.

Payments rise by the highest of the previous September's consumer prices index (CPI) inflation figure, average earnings growth from the previous May to July, or 2.5 per cent.

It means that vulnerable pensioners surviving on the state pension alone have until now been exempt from handing more of their income back to the state.

These retirees would today need just £23 of income every year from a private or workplace pension to trigger an income tax bill.

However, the full, new state pension is set to breach the tax-free personal allowance for the first time next year.

As the personal allowance has been frozen since 2021, pension payments have been climbing every year in line with the triple lock, bringing them closer to that threshold

This is a process known as fiscal drag, and is set to force even low-income vulnerable pensioners surviving on just the state pension alone into the tax system from April.

Even if the amount climbs by the minimum 2.5 per cent under the triple lock, annual payments will rise to £12,860 in April next year.

Although in reality, this is likely to be higher if the payments climb by either the inflation or wage growth metric instead.

It means that pensioners will receive £290 more than the tax-free allowance, triggering a tax bill of £58 if they have no other income.

Reeves previously said that those surviving on the state pension alone would not have to 'fill in a tax return', but added she was 'working on a solution'.

She insisted that during this Parliament, this group wouldn't have to pay the tax.

If these proposals go ahead, it could breach this promise if pension payments to these low-income retirees are taxed at source.

Neither the Treasury or the DWP has confirmed how such a plan would work in practice. However, the move could spark confusion for retirees and an administrative nightmare for the tax office.

One of the options being discussed, for example, is taxing all state pension payments at 20 per cent – the basic rate of tax.

At the end of the tax year this would then be reconciled with the tax owed by pensioners with their other incomes, according to reports from City AM.

A spokesman for the DWP says: 'There has been no change to the tax treatment of the state pension.

'The Government routinely undertakes research to better understand pensioners' experiences with the tax system.'