Trivial pensions again

Milarky

According to the site http://sharingpensions.co.uk, trivial 'commutation' [conversion of a small pension where total pension assets are less than 1 percent of the 'cap' or lifetime allowance] only attracts tax [of the 'earned income'] on 75 percent of the fund -not the full fund- the other 25 percent comprising the lump sum that is tax free is other cases anyway.

'Loophole' spotted:
If the person's position allows them to commute at the qualifying age [60-75?] but they then use the commuted sum to fund a subsequent pension-from-scratch, this pension will then be worth more than the uncommuted pension would have been.

Example given at: http://sharingpensions.co.uk/pensions_simplification.htm

Fund £15,000

25% tax fee cash
£3,750

Taxable fund
£11,250

Basic rate tax (22% April 2004) £2,475

Net lump sum £8,775

Total pension lump sum £12,525

Now continue....

Make £12,525 'net' pension contribution, plus 22% relief = £16,057

So the fund of £15,000 has become one of £16,000 and some odd £s.

Granted it is a once-only exercise [otherwise, for instance, commutation could occur every year whilst the sum was less still than £15,000 and starting at age 60, and with no non-state pension assets, a pensioner could simply commute each year for a 'free' 7% pa growth on top....] so this would be a once only 7% instead...

I had wondered about this and it seems to me that there is a flaw in the trivial pension regime in allowing the tax free lump sum to survive its application. If instead all the fund was taxed at the earned-income rate then this loophole would disappear because...

£15,000 minus 22% tax = £11,700

£11,700 plus 22% tax relief = £15,000

isasmurf

Didn't the Chancellor announce in the PBR this 'loophole' is to be closed?

http://www.hmrc.gov.uk/pbr2005/pensions-simplification.pdf

The Government is also taking action to stop the potential abuse of
the pension tax simplification rules by means of a device designed to
boost the amount in a pension scheme through the artificial
generation of tax reliefs. The device works by the scheme member
withdrawing a tax free lump sum which is reinvested back into a
registered pension scheme, automatically generating further tax relief
on the amount reinvested. This in turn allows a further tax free lump
sum to be paid out, so that the cycle can be repeated. This has
become known as “recycling”.

[snip]

To prevent individuals from artificially boosting their pension funds by
recycling tax free lump sums in this way an anti-avoidance rule will be
inserted into the new pension tax simplification legislation, to take
effect from 6 April 2006 (A-Day). The legislation will target cases
where lump sums are taken with the sole or main purpose of
reinvesting them in a pension scheme to create additional pensions
savings through the additional tax relief granted.

Milarky

isasmurf wrote:

Didn't the Chancellor announce in the PBR this 'loophole' is to be closed?

http://www.hmrc.gov.uk/pbr2005/pensions-simplification.pdf

Don't think it's quite the same thing, isasmurf. People with small enough funds will be able to commute them - and those same people will be then be able to contribute up to 100% of salary into a pension scheme started after trivial commutation - that's not what these rule-tightenings will address.

But, as I say, there would be no scope to do this if the whole of the commuted sum was taxed as income. The 'anomaly' lies with the lump sum.

In any case, it would be rare for someone aged 60 to want to do this with their newly released capital and it is quite a 'small' loophole in comparison with the 'abuse' mentioned in the piece.