Paying a Redundancy payment into a SIPP to get tax relief, followed by withdrawing a TFLS
Been a lurker for a while, here’s my first post…. Go easy on me
My wife is about to take voluntary redundancy from the NHS. She is 56, salaried at £48k. She will receive a pre-tax VR payout of approx £50k.
This is all happening very quickly. She will receive notification of a successful (or not) application for VR in the next 7 days, and then if successful, she will finish at the end of the month (March 2023) with the VR payment paid in her final end-of-March salary.
She doesn’t intend to work for the next 12 months (she may even
never get another job, but that is not yet decided, as we both intend to retire
in the next 2-3 years), so she would have no planned taxable income in the next tax year
(2023/24). Ideally, she would have liked to have received the VR payment after
6th April (i.e., in the 2023/24 tax year) to make best use of her allowances
in that tax year, but that is not possible under the rules of the VR process.
She has been contributing into her NHS pension ("2015 scheme"), which will be left in place until she can start claiming it at NPA. She was paying approx. £300 per month ( £3600 p.a.) into it. That will stop at the end of March.
Just exploring legal ways to minimise the income tax burden
on her VR payout...
As I understand it, the 1st £30k of the VR payout is tax free, but then the balance of £20k will be taxed in her end-of-March salary. She is currently taxed at the basic rate (20%) on her £48k salary, but the additional £20k taxable portion of the VR payment will push her into the higher rate (40%) tax bracket I assume.
Q1. My question is,
could she pay the net (after tax) VR payment into a new SIPP (to be setup pretty
quickly), in order to receive tax relief ? I
calculate that after tax she will receive approx. £42 of the VR payout (£30k + £12k out of the taxed £20k portion). If she could pay the £42k into a SIPP, how
would the pension company/HMRC know that she hadn’t paid tax on the 1st
£30K part, and hence only the £12k part would be eligible for tax relief.? Surely she doesnt get tax relief on the full £42k ?
Q2. Assuming YES to Q1, then because she is over 55, could she immediately withdraw a 25% TFLS from the SIPP to live off for the next 12 months? Is this allowed ? Is there any minimum elapsed time needed between setting up & paying a lump sum into a SIPP and then withdrawing a TFLS from it ?
We are unsure if you could open a SIPP just to pay in a lump sum to obtain tax relief on, and then immediately withdraw a TFLS. Or are we completely wide of the mark ?
Are there any other options ?
Thanks in advance.
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HMRC look at pension contributions over a 5 year period, 2 years prior to TFLS, the year the TFLS was taken, and the 2 following years to see if pension contributions have increased. If they have increased significantly they may consider that recycling of TFLS has occurred.
It may not matter where the money used to contribute to the pension actually came from. If the contributions were increased significantly within this 5 year window you may fall foul of the recycling rules.
Full rules are here - https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm133800
@Hereford291 For your first question the important figure is 48k as that's your wife's salary for this tax year and the most you can claim tax relief on in a Pension. However there is a Annual Allowance of 40k per year for contributions to pensions, but you are allowed to use up to the last three years unused allowance to extend this.
A further complication is the NHS pension will be using and have used in the past three years some of this allowance. Your wife needs to ask her pension admin for the PIA (pension input amount) for the NHS pension to determine how much AA you actually have to use this year.
FYI, a new pension can be set up online in 10 minutes, although you will probably have to wait a few days for all passwords to be sent etc
OP is considering significantly increasing pension contributions then soon after taking a TFLS. If you care to read the HMRC guide I posted I think you'll find that unless they wait >2 years before taking the TFLS they may fall foul of recycling rules.
Paragraph 3A Schedule 29 Finance Act 2004
The recycling rule applies in respect of all pension commencement lump sums paid on or after 6 April 2006, where those lump sums are used as part of a recycling device, regardless of when the significantly increased contributions are actually paid. The recycling rule applies when all of the following conditions are met:
I've researched this in some depth and concluded that I could fall foul of recycling rules if I increase annual contributions by more than about 10% of my TFLS.
I think the OP could also fall foul of recycling rules too. He could fail the significant increase test if significant pension contribution were made in the 2 tax years immediately preceding the tax year in which the individual took the lump sum. I understand that is what he is planning?
"What is the cumulative basis on which the significant increase of contributions is based?
An individual planning to increase contributions significantly to a registered pension scheme when taking a pension commencement lump sum does not avoid the ‘significant increase’ test by increasing contributions piecemeal or gradually over time. It does so by providing for contributions to be measured over a set period of time in determining whether or not there has been a significant increase in contributions.
The period of time is:
How would one prove to HMRC that regardless of the redundancy settlement, the increased pension contributions and a TFLS the following year were in no way connected? Good luck with that!
- the tax year in which an individual takes a pension commencement lump sum with the intention of using it to make significantly increased contributions to a registered pension scheme
- the 2 tax years immediately preceding the tax year in which the individual took the lump sum
- the 2 tax years immediately following the tax year in which the individual took the lump sum."
Firstly if your wife's salary is £48k and she's a member of the NHS 2015 scheme you will no doubt find her taxable pay is actually only sub £45k as her pension contributions to the NHS 2015 scheme will have been using the net pay method.
Secondly there is no direct link between the tax she pays and contributions made using the RAS method. If she paid £42k into a SIPP then the pension company would add £10,500 in basic rate tax relief making a gross contribution of £52,500.
RAS contributions do not reduce your taxable income but they do increase your basic rate band, meaning more income can be taxed at 20% and less at 40%. That is a personal tax saving on top of the basic rate tax relief added to the pension fund. It will benefit your wife, it is not added to her SIPP pension fund.
To get this right from a tax perspective you really need to work out what her taxable earnings will be for 2022:23 i.e. assuming no other job it will be her taxable pay to February (presumably shown on her latest payslip) plus the taxable pay due in March.
Using your suggested figures her pension input amount (relating to the NHS 2015 DB scheme) plus gross DC contribution to the SIPP are clearly going to exceed her £40k annual allowance so you will also need to look at her carry forward position to make she she is actually able to make such a large DC contributions without incurring an annual allowance charge.
If either of you receive Child Benefit then the SIPP contribution could help her reduce (or totally eradicate) any High Income Child Benefit Charge that might otherwise be due.
So you will definitely need to use carry forward to put more than £28.4k in. I suspect using carry forward won’t be a problem though.
A1. The first £30k redundancy is paid tax free so you would only need to deposit the excess (£20k gross) into a SIPP to avoid 40% tax.
I would open a SIPP with HL this month and pay in £16k* by debit card. This will be grossed up to £20k by 22 May 23.
A2. You are free to withdraw the £5k TFLS any time following this (ie > 23 May 23).
A3. As above.
(*If affordable, you could pay in up to £32k, giving £40k gross and £10k TFLS)
No worries about recycling with any of this.