Up to one million pensioners could be protected from income tax under plans expected to be announced in Wednesday’s Budget.

Chancellor John Healey is reportedly considering raising the tax-free allowance for low-income pensioners to match the new full state pension, with further increases linked to the state pension for the remainder of the parliament. The measure is expected to cost the Treasury £200m a year by 2030.

The protection would apply to pensioners whose only income is the state pension, while those with additional income, including private pensions, could still face tax, according to The Times.

The full state pension is expected to rise by £488.80 a year to £13,036.40, an increase of 3.9%. This would exceed the current £12,570 personal allowance, potentially leaving pensioners with an income tax bill despite having no other income.

The plans follow a commitment by former Chancellor Rachel Reeves that pensioners whose only income is the state pension would not have to pay income tax on it.

There could also be relief for pension savers, with reports suggesting the Chancellor has decided against reducing the maximum tax-free pension lump sum. Savers can currently withdraw 25% of their pension tax-free, up to £268,275, with speculation that the limit could be cut to £100,000.

Steve Webb, a partner at pension consultancy LCP, told The Times: “This looks like being a decidedly pensioner-friendly budget.”

Critics have warned that the proposals could create a two-tier system among retirees as the state pension increase threatens to push retirees who rely solely on it above the personal allowance, although the eligibility criteria have yet to be confirmed.

Kate Smith, head of pensions at Aegon, said: "If these reports are confirmed, protecting those who rely solely on the State Pension from paying income tax will be welcome news for some of the lowest-income pensioners.

"However, there is a risk that creating a more generous tax position for those who have not built-up additional retirement savings could be seen as unfair by people who have had the means to do the right thing and saved through workplace and private pensions.

"Long-term pensions policy should be guided by fairness across generations and between different groups of savers, rather than short term measures designed to fix one specific issue. Any reforms need to support adequacy, reward saving and command confidence across the whole retirement system."

Patrick Thomson, head of research analysis and policy at Standard Life Centre for the Future of Retirement, added: "Much will depend on the detail of the protection and who qualifies. If it applies only to those whose sole income is the State Pension, people with even relatively modest workplace or private pension income could still be affected.

"What looks like a relatively simple solution could become more complicated over time as the State Pension continues to rise against a frozen Personal Allowance, widening the difference in tax treatment between those relying on the State Pension alone and those with relatively small amounts of additional retirement income."

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