On the back of my recent article on taking tax-free cash from your pension, we’ve had several questions about exactly how HMRC’s ‘recycling’ rules work.

Rather than address all those questions individually we figured it would be simpler to dedicate a few extra column inches to the subject.

The concept of recycling is fairly straightforward. Let’s take a member who is 60-years-old and has a £40,000 SIPP fund. She takes out her maximum tax-free cash (i.e. £10,000) but then invests that straight back into a pension with a different provider.

The result? She gets tax relief on the money she pays into that pension (immediately boosting it to £12,500) and can get 25% of that money (i.e. £3,125) tax-free too. She might even invest that in another scheme – and so the wheeze goes on.

Sounds too good to be true? Sadly (and perhaps unsurprisingly) it is. The Government has quite stringent rules in place to prevent excessive recycling of tax-free cash. If you breach these rules you could be hit with a 55% unauthorised payment charge.

HMRC will only consider recycling of tax-free cash to potentially breach its rules where the tax-free sum (or sums) received over a 12 month period are worth more than £7,500.

Even then, the rules will only kick in where the payment has resulted in a 30% or more increase in contributions to your pension compared to what might normally have been expected.

While this sounds a bit woolly, it’s actually a specific condition – HMRC looks at contributions paid in the rest of the tax year after you took your tax-free cash plus up to two subsequent years. This is then compared with the contributions made during a similar period before tax-free cash was taken.

You can’t get round this by paying into different pension schemes as HMRC will look at all of your contributions when making its assessment.

Equally, HMRC will penalise you for recycling if you borrow money to pay contributions or pay into your pension out of savings and then use the tax-free lump sum to pay off the loan or top up savings.

In short, recycling can be used to get extra tax-free cash, but only within strict HMRC-imposed limits. And if you get it wrong, the penalty will be severe.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to editorial@sharesmagazine.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide guidance and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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