I’d be interested in a high level run through of pension recycling rules as it seems a very grey area. For example, if we were to have more disposable income if we paid off our mortgage with my pension lump sum, would it be OK to pay more money into my self-employed partner’s pension? Or is that recycling?

Mike

Tom Selby, AJ Bell Head of Retirement Policy, says:

HMRC has rules in place designed to prevent people manipulating the pension system to get extra tax relief. As you say, this concept is referred to by the taxman as ‘recycling’ and applies specifically to your use of the 25% tax-free lump sum entitlement.

It’s probably easiest to demonstrate how recycling might work with an example. Let’s assume someone is 65 years old and has a SIPP valued at £40,000. They take out their maximum tax-free lump sum (£10,000) but rather than spending it, invest it straight back into their SIPP.

As a result, they get basic-rate tax relief on the ‘new’ contribution (immediately boosting the value of the contribution by £2,500 to £12,500) and can then access 25% of that money (£3,125) tax-free as well.

Clearly such behaviour presents a significant risk to the Treasury – which is why HMRC has rules in place designed to prevent excessive recycling. Anyone who breaks these rules risks being hit with an unauthorised payment charge of 40% or 55% (depending on the circumstances) of the contribution.

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

The rules kick in where the payment of a tax-free lump sum has resulted in a 30% or more increase in contributions to your pension compared to what might normally have been expected.

Although this might sound a bit vague, 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 more years afterwards. 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.

If you are at all uncertain about how these rules might apply in your specific circumstances, it’s worth speaking to a regulated financial adviser before doing anything, particularly if you’re thinking about making large contributions.           

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to asktom@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 information 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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