Pension recycling: what is it and what are the rules?
Pension recycling is a way of using some of your tax-free lump sum to bump up your pension and cash in on tax breaks. Find out how it works and what the rules are.
Pension recycling involves taking money out of your pension (typically your tax-free lump sum) and then paying it back in gain to get additional tax relief.
But, while it might sound like a straightforward way of boosting your retirement savings, there are strict rules to follow, to prevent savers abusing pension tax relief rules.
Find out more about the rules and regulations with our guide.
Pension recycling is a way to boost your pension contributions and gain extra tax relief.
There are examples where a boost to your pension payments won’t normally be counted as pension recycling.
There’s nothing inherently wrong with pension recycling, but it can be a complex and legally tricky area.
An expert financial adviser can help you navigate complex pension strategies to optimise your retirement planning.
What are the pension recycling rules?
You can use pension recycling to boost your pension contributions and gain extra tax relief.
Tax relief is equivalent to the rate of income tax you pay, so 20% for basic rate taxpayers, 40% for those that pay the higher rate and 45% for additional rate taxpayers.
That means it can give your pension contributions a significant boost.
However, to prevent people from exploiting the rules and benefiting from artificially high tax relief, HMRC imposes significant charges on those that break the rules.
This includes an unauthorised payment charge of 40%, and in some cases an unauthorised payment surcharge of 15%.
The scheme may also have to pay 15% if they knowingly make an unauthorised payment.
These rules are designed to prevent exploitation of the pension system for undue tax benefits and are not usually applied to ‘normal’ retirement planning.
So, when could you be affected by the pension recycling rules?
If all of the things below happened, you could incur a tax charge from HRMC:
You take a tax-free lump sum from a pension
Contributions paid into a pension are larger than they would have been, because you have added some tax-free cash
After assessing your case, HMRC has decided that the recycling was pre-planned
The amount of tax-free cash you take is more than £7,500, when added to any tax-free cash taken in the previous 12 months
The amount of all additional contributions exceeds 30% of the tax-free cash
As a guide, HMRC is generally only concerned if it sees an increase in excess of 30% on expected contributions. Only then will it consider applying the extra tax charge.
Here are two examples, which show how you would be exempt, and how you could be liable.
Example 1: the right side of the rules
You take £5,000 tax-free from a pension and reinvest it in another pension plan.
As long as you had no other tax-free cash in the previous 12 months, you would not be caught by the recycling rules, as the cash did not exceed £7,500.
Example 2: the wrong side of the rule
You’ve been contributing £5,000 a year into a pension, and you then make a £100,000 contribution and subsequently take out pension benefits that include £100,000 in tax-free cash.
This was clearly pre-planned and exceeds the 30% tax-free cash limit too, so is caught by the recycling rules.
What doesn’t count as pension recycling?
As you approach retirement, it’s totally understandable that you’ll want to boost your pension.
However, once you have taken your tax-free lump sum, you’ll need to be mindful of pension recycling rules.
Thankfully not every pension top up counts as pension recycling.
Here are some examples where a boost to your pension payments won’t normally be counted as pension recycling:
You pay a standard amount into your employer pension scheme, even if you move to a higher paid job and subsequently increase your pension contributions.
You receive a windfall, like an inheritance, and pay more into your pension.
Your business has a good year so you pay more into your pension (assuming the percentage of your contributions is the same).
It may also be helpful to note that pension recycling rules only apply to contributions to your own pension.
You could, alternatively, take tax-free cash from your pension and pay into your spouse or partner’s pension instead.
What are the pension recycling risks?
There’s nothing inherently wrong with pension recycling.
The problem is it’s a complex and legally tricky area.
Make a mistake, and the tax charges could outweigh the benefits.
This means if you’re thinking about recycling part of your tax-free lump sum, it’s essential to do some research so that you understand the HMRC rules and restrictions.
It will also be sensible to take professional advice.
Get expert pension advice
Pension recycling can be a smart way to boost your retirement savings and take advantage of tax relief.
However, the rules are complicated, so it’s important to know the ins and outs to avoid unexpected tax charges.
This means you should seek professional advice from a financial planner or accountant.
They will be up to speed on the latest legislation and can ensure you don’t fall foul of the rules.
With the right approach, you can make the most of your pension and ensure you make the best decisions for your financial future.
Let Unbiased quickly match you with a financial adviser for expert financial advice tailored to your specific needs and help you navigate complex pension strategies to optimise your retirement planning.
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