Pension Recycling am I over worrying?

Pat38493

I would appreciate some comments about whether I am being over cautious here.

I contribute to my pension through employer salary sacrifice and my contributions are as follows:

2020/21 tax year and earlier – around £14.5K or less.

2021/22 £24K  (increase > 30%)

2022/23 £44K (increase > 30%)

2023/24 forecast £57K (increase > 30%)

2024/25 and beyond – not greater than £44K.

I would like to take out tax free cash either in 24/25 tax year or 25/26 tax year (or both) to pay down my mortgage and I am also considering (but not sure) stopping or reducing work in one of those 2 years which would obviously entail taking TFC one way or another.

HMRC Tests:

• My pension contributions increased by more than 30% cumulatively in the tax year when tax free cash will be taken and the 2 tax years before and 2 tax years following – yes.
• The TFLS will be > £7.5K – yes.
• The amount of pension increases in the earlier years is more than 30% of the TFLS taken – yes it will be.

Does this mean I would be accused of recycling?

My argument would be:

• The pension amounts did not increase from what they “otherwise would be”.  When I made the decision to increase my pension contributions in earlier years it was from a general understanding that I needed to make big increases to my pension provision – I think that I had never even heard of the recycling rules until about  year ago and I had not researched how to take money out of the pension.
• In May 2021 I had a free 1 hour consultation with an IFA and it was subsequent to this that I realized I was paying 60% tax trap and wasting a lot of 40% tax relief and I needed to pay a lot more into my pension.
• There was no pre-planning at the time I made the decision to increase the pension contributions and according to HMRC, in the situation where the pension contribution increases happened before the lump sum is taken “pre-planning occurs when the significantly increased contribution is made - this is the “relevant time”.”.  I was not planning to recycle tax free cash when I decided to increase my pension contributions in 2021 or 2022 or 2023.  In the first 2 years, I was not even aware that such rules existed and in 2023, I was taking advantage of increased annual allowances and potential for reduced spending due to reduced childcare costs.
• I will be able to show that the amount of the TFLS taken is paid into the mortgage, unless I decide to stop work completely at that time.
• My net income in the last years even after increased pension contributions was broadly sufficient to support my lifestyle spending i.e. I was not funding the extra pension contributions from additional borrowing or suchlike.
• If I wanted to retire during the few years, there is no way I can do that without being effectively “forced” to take tax free cash so I don’t really have a choice.  It would appear normal to me to increase pension contributions substantially in the approach to retirement so this should surely be “normal retirement planning”.

Is my reasoning sound here and also, would I get any indirect protection from hiring an IFA to advise on this matter? i.e. could I sue the IFA if they said it would be ok to take that TFLS and then HMRC considered it an unauthorized payment?

 

 

Marcon

Pat38493 said:

I would appreciate some comments about whether I am being over cautious here.

I contribute to my pension through employer salary sacrifice and my contributions are as follows:

2020/21 tax year and earlier – around £14.5K or less.

2021/22 £24K  (increase > 30%)

2022/23 £44K (increase > 30%)

2023/24 forecast £57K (increase > 30%)

2024/25 and beyond – not greater than £44K.

I would like to take out tax free cash either in 24/25 tax year or 25/26 tax year (or both) to pay down my mortgage and I am also considering (but not sure) stopping or reducing work in one of those 2 years which would obviously entail taking TFC one way or another.

HMRC Tests:

• My pension contributions increased by more than 30% cumulatively in the tax year when tax free cash will be taken and the 2 tax years before and 2 tax years following – yes.
• The TFLS will be > £7.5K – yes.
• The amount of pension increases in the earlier years is more than 30% of the TFLS taken – yes it will be.

Does this mean I would be accused of recycling?

My argument would be:

• The pension amounts did not increase from what they “otherwise would be”.  When I made the decision to increase my pension contributions in earlier years it was from a general understanding that I needed to make big increases to my pension provision – I think that I had never even heard of the recycling rules until about  year ago and I had not researched how to take money out of the pension.
• In May 2021 I had a free 1 hour consultation with an IFA and it was subsequent to this that I realized I was paying 60% tax trap and wasting a lot of 40% tax relief and I needed to pay a lot more into my pension.
• There was no pre-planning at the time I made the decision to increase the pension contributions and according to HMRC, in the situation where the pension contribution increases happened before the lump sum is taken “pre-planning occurs when the significantly increased contribution is made - this is the “relevant time”.”.  I was not planning to recycle tax free cash when I decided to increase my pension contributions in 2021 or 2022 or 2023.  In the first 2 years, I was not even aware that such rules existed and in 2023, I was taking advantage of increased annual allowances and potential for reduced spending due to reduced childcare costs.
• I will be able to show that the amount of the TFLS taken is paid into the mortgage, unless I decide to stop work completely at that time.
• My net income in the last years even after increased pension contributions was broadly sufficient to support my lifestyle spending i.e. I was not funding the extra pension contributions from additional borrowing or suchlike.
• If I wanted to retire during the few years, there is no way I can do that without being effectively “forced” to take tax free cash so I don’t really have a choice.  It would appear normal to me to increase pension contributions substantially in the approach to retirement so this should surely be “normal retirement planning”.

Is my reasoning sound here and also, would I get any indirect protection from hiring an IFA to advise on this matter? i.e. could I sue the IFA if they said it would be ok to take that TFLS and then HMRC considered it an unauthorized payment?

 

 

I haven't read your whole post - just the beginning and end - but that was enough to tell me you are over-thinking things.

You won't get any protection by getting an IFA to advise, because they won't give you the definitive answer you'd need to put them in the firing line should HMRC ever decide what you are planning is recycling. The position is so hopelessly murky that the simple answer, whatever anyone might say to the contrary, is 'nobody knows for sure'. HMRC's response to FOI requests is that it is disproportionately expensive to provide information because each case is considered individually (which suggests they haven't got any records of their own to say how many people have been caught by these rules and might not have a clue).

The onus would be on HMRC to prove that you took tax free cash with the aim of recycling - and that's very hard to prove, especially where someone can demonstrate they've actually used the cash for other purposes.

Nobody here can give you the categoric reassurance you believe you need. In short, the call is yours - but possibly nothing like the level of 'risk' you fear.

Pat38493

Marcon said:

Pat38493 said:

I would appreciate some comments about whether I am being over cautious here.

I contribute to my pension through employer salary sacrifice and my contributions are as follows:

2020/21 tax year and earlier – around £14.5K or less.

2021/22 £24K  (increase > 30%)

2022/23 £44K (increase > 30%)

2023/24 forecast £57K (increase > 30%)

2024/25 and beyond – not greater than £44K.

I would like to take out tax free cash either in 24/25 tax year or 25/26 tax year (or both) to pay down my mortgage and I am also considering (but not sure) stopping or reducing work in one of those 2 years which would obviously entail taking TFC one way or another.

HMRC Tests:

• My pension contributions increased by more than 30% cumulatively in the tax year when tax free cash will be taken and the 2 tax years before and 2 tax years following – yes.
• The TFLS will be > £7.5K – yes.
• The amount of pension increases in the earlier years is more than 30% of the TFLS taken – yes it will be.

Does this mean I would be accused of recycling?

My argument would be:

• The pension amounts did not increase from what they “otherwise would be”.  When I made the decision to increase my pension contributions in earlier years it was from a general understanding that I needed to make big increases to my pension provision – I think that I had never even heard of the recycling rules until about  year ago and I had not researched how to take money out of the pension.
• In May 2021 I had a free 1 hour consultation with an IFA and it was subsequent to this that I realized I was paying 60% tax trap and wasting a lot of 40% tax relief and I needed to pay a lot more into my pension.
• There was no pre-planning at the time I made the decision to increase the pension contributions and according to HMRC, in the situation where the pension contribution increases happened before the lump sum is taken “pre-planning occurs when the significantly increased contribution is made - this is the “relevant time”.”.  I was not planning to recycle tax free cash when I decided to increase my pension contributions in 2021 or 2022 or 2023.  In the first 2 years, I was not even aware that such rules existed and in 2023, I was taking advantage of increased annual allowances and potential for reduced spending due to reduced childcare costs.
• I will be able to show that the amount of the TFLS taken is paid into the mortgage, unless I decide to stop work completely at that time.
• My net income in the last years even after increased pension contributions was broadly sufficient to support my lifestyle spending i.e. I was not funding the extra pension contributions from additional borrowing or suchlike.
• If I wanted to retire during the few years, there is no way I can do that without being effectively “forced” to take tax free cash so I don’t really have a choice.  It would appear normal to me to increase pension contributions substantially in the approach to retirement so this should surely be “normal retirement planning”.

Is my reasoning sound here and also, would I get any indirect protection from hiring an IFA to advise on this matter? i.e. could I sue the IFA if they said it would be ok to take that TFLS and then HMRC considered it an unauthorized payment?

 

 

I haven't read your whole post - just the beginning and end - but that was enough to tell me you are over-thinking things.

You won't get any protection by getting an IFA to advise, because they won't give you the definitive answer you'd need to put them in the firing line should HMRC ever decide what you are planning is recycling. The position is so hopelessly murky that the simple answer, whatever anyone might say to the contrary, is 'nobody knows for sure'. HMRC's response to FOI requests is that it is disproportionately expensive to provide information because each case is considered individually (which suggests they haven't got any records of their own to say how many people have been caught by these rules and might not have a clue).

The onus would be on HMRC to prove that you took tax free cash with the aim of recycling - and that's very hard to prove, especially where someone can demonstrate they've actually used the cash for other purposes.

Nobody here can give you the categoric reassurance you believe you need. In short, the call is yours - but possibly nothing like the level of 'risk' you fear.

Thanks Marcon - are you an IFA by the way?  Maybe I am over stating it by looking for a cast iron assurance, but I guess an IFA would still be able to make some comments?  If they said - I've had 20 clients do something very similar in the last 10 years and none of them ever had any problems yet, that is already quite reassuring.  If on the other hand they said "noooooo! don't do that as I had a client under investigation by HMRC for doing the same thing last week", that's different.

Marcon

Pat38493 said:

Marcon said:

Pat38493 said:

I would appreciate some comments about whether I am being over cautious here.

I contribute to my pension through employer salary sacrifice and my contributions are as follows:

2020/21 tax year and earlier – around £14.5K or less.

2021/22 £24K  (increase > 30%)

2022/23 £44K (increase > 30%)

2023/24 forecast £57K (increase > 30%)

2024/25 and beyond – not greater than £44K.

I would like to take out tax free cash either in 24/25 tax year or 25/26 tax year (or both) to pay down my mortgage and I am also considering (but not sure) stopping or reducing work in one of those 2 years which would obviously entail taking TFC one way or another.

HMRC Tests:

• My pension contributions increased by more than 30% cumulatively in the tax year when tax free cash will be taken and the 2 tax years before and 2 tax years following – yes.
• The TFLS will be > £7.5K – yes.
• The amount of pension increases in the earlier years is more than 30% of the TFLS taken – yes it will be.

Does this mean I would be accused of recycling?

My argument would be:

• The pension amounts did not increase from what they “otherwise would be”.  When I made the decision to increase my pension contributions in earlier years it was from a general understanding that I needed to make big increases to my pension provision – I think that I had never even heard of the recycling rules until about  year ago and I had not researched how to take money out of the pension.
• In May 2021 I had a free 1 hour consultation with an IFA and it was subsequent to this that I realized I was paying 60% tax trap and wasting a lot of 40% tax relief and I needed to pay a lot more into my pension.
• There was no pre-planning at the time I made the decision to increase the pension contributions and according to HMRC, in the situation where the pension contribution increases happened before the lump sum is taken “pre-planning occurs when the significantly increased contribution is made - this is the “relevant time”.”.  I was not planning to recycle tax free cash when I decided to increase my pension contributions in 2021 or 2022 or 2023.  In the first 2 years, I was not even aware that such rules existed and in 2023, I was taking advantage of increased annual allowances and potential for reduced spending due to reduced childcare costs.
• I will be able to show that the amount of the TFLS taken is paid into the mortgage, unless I decide to stop work completely at that time.
• My net income in the last years even after increased pension contributions was broadly sufficient to support my lifestyle spending i.e. I was not funding the extra pension contributions from additional borrowing or suchlike.
• If I wanted to retire during the few years, there is no way I can do that without being effectively “forced” to take tax free cash so I don’t really have a choice.  It would appear normal to me to increase pension contributions substantially in the approach to retirement so this should surely be “normal retirement planning”.

Is my reasoning sound here and also, would I get any indirect protection from hiring an IFA to advise on this matter? i.e. could I sue the IFA if they said it would be ok to take that TFLS and then HMRC considered it an unauthorized payment?

 

 

I haven't read your whole post - just the beginning and end - but that was enough to tell me you are over-thinking things.

You won't get any protection by getting an IFA to advise, because they won't give you the definitive answer you'd need to put them in the firing line should HMRC ever decide what you are planning is recycling. The position is so hopelessly murky that the simple answer, whatever anyone might say to the contrary, is 'nobody knows for sure'. HMRC's response to FOI requests is that it is disproportionately expensive to provide information because each case is considered individually (which suggests they haven't got any records of their own to say how many people have been caught by these rules and might not have a clue).

The onus would be on HMRC to prove that you took tax free cash with the aim of recycling - and that's very hard to prove, especially where someone can demonstrate they've actually used the cash for other purposes.

Nobody here can give you the categoric reassurance you believe you need. In short, the call is yours - but possibly nothing like the level of 'risk' you fear.

Thanks Marcon - are you an IFA by the way?  Maybe I am over stating it by looking for a cast iron assurance, but I guess an IFA would still be able to make some comments?  If they said - I've had 20 clients do something very similar in the last 10 years and none of them ever had any problems yet, that is already quite reassuring.  If on the other hand they said "noooooo! don't do that as I had a client under investigation by HMRC for doing the same thing last week", that's different.

I'm not an IFA (I think forum rules require IFAs to disclose in their footers if they are).

Hopefully one of the IFAs posting regularly on this forum might be able to answer your question, but the problem is finding 'identical circumstances' (or very similar ones).

 

Pat38493

[Deleted User] said:

Looking at your arguments:

1. Whether you know about the recycling rules is not relevant to the tax treatment.
2. The making of extra contributions to deal with the 60% marginal rate would be very relevant.  Obviously it is important that the facts fit (e.g. that the contributions actually saved you some 60% tax).
3. Just saying that you had "a general understanding that I needed to make big increases to my pension provision" doesn't really swing anything for me but see my comments on your IFA meeting below.
4. "There was no pre-planning at the time I made the decision to increase the pension contributions".  That's key but you go on to say that you're going to use the PCLS to pay off your mortgage. If that was in your mind when you increased your salary sacrifice then that suggests that there was pre-planning.  Especially if absent the PCLS you would have paid down your mortgage.
5. "My net income in the last years even after increased pension contributions was broadly sufficient to support my lifestyle spending".  That's not relevant at one level.  But it might be good evidence that you would have made larger contributions regardless of the tax-free nature of the PCLS.
6. "If I wanted to retire during the few years, there is no way I can do that without being effectively “forced” to take tax free cash so I don’t really have a choice".  That's reads to me as you trying to mislead.  You are not forced to take a PCLS of that magnitude.  You could take no, or a smaller lump sum, on retirement (or reaching age 55) and then take one or more lump sums later.
7. "It would appear normal to me to increase pension contributions substantially in the approach to retirement so this should surely be 'normal retirement planning'".  Yes, but that's not helpful if you do it to get a bigger PCLS.  However, a consultation with an IFA where it became clear that "I needed to pay a lot more into my pension" is relevant.  The question then is how much more you would have paid but for the PCLS.

I have no idea who you are or what your circumstances are.  However, if as you got older you found that you had more income, had higher marginal tax rates and found your pension was going to provide less than you hoped in retirement then these are all great reasons for making extra contributions that have nothing to do with the PLCS.  On the other hand, if the IFA told you about a great wheeze of making extra contributions now to get a bigger tax-free PCLS then, well, the position would be different.  Similarly, if you paid £120,000 into your pension on Monday and took a big PCLS on Tuesday then that would not be helpful.

Thanks - I pick out a couple of points from your reply in bold. 

I'm not clear how not knowing about the rules is irrelevant - surely it's impossible to pre-plan something if you don't even know it exists or what it means at the time?

If I stop work which was one possibility I mentioned, I need to take money out of DC pensions to live.  I am not aware of a way to take money out of DC pensions without taking at least a portion of it as tax free cash (other than buying an annuity and insisting that I don't want any TFC, but surely HMRC aren't going to say - you should have bought an annuity - if it doesn't suite my overall retirement plan).  Even if I take a UFPLS some of it will be tax free cash.

Also as an additional point, as a 40% tax payer, it would have been beneficial from a tax point of view for me to increase my pension contributions even if there was no such thing as PCLS lump sums.

I have never had any history of over-paying my mortgage regularly from taxed income - the only over payment we ever previously made was with my wife's PCLS.  I don't think it was "in my mind" to pay off my mortgage with a PCLS at the time - I was just generally made aware that if I started saving more I would probably be able to retire a lot earlier than 65, which was not previously my thinking as at the time, I was being guided by the very low "on retirement you can expect to get x" from official pension estimates.  

Another additional point is that at the time I originally increased my pension contributions, to the extent that I would have even considered it in detail, I was probably planning to keep my mortgage open as interest rates were 1-2% at the time and nobody knew they were going to go up so quickly.  If interest rates were still that low I would certainly re-mortgage instead of paying it off.

In general - all these things on my side are flexible - am I planning to use TFC to retire next year? Perhaps, but not sure.  Am I planning to pay off my mortgage next year - probably but not certain.  Maybe I will work part time instead and only take smaller amounts.  Maybe interest rates will go down and I will re-mortgage instead of paying it off.  I was also under threat of potential redundancy this year (and arguably still am) which would also obviously change my situation.

Andreg

I am not a financial adviser so take the following with a pinch of salt.  The five year period that HMRC look at is defined as follows:

• the tax year in which the tax-free cash was taken,

• the two tax years before the tax year that the tax-free cash was taken, and

• the two tax years after the tax year that the tax-free cash was taken

If tax-free cash was taken in tax year 2024/25, the testing period would be from 2022/23 to 2026/27.  

There are two 30% rules: 1) have contributions increased more than 30% above what might have been expected and 2) are the additional contributions more than 30% of the TFLS.  So, applying the second rule, if you retire in April 2024, earn nothing after that and take more than £336k tax free cash at that time, then the £44k you contributed in 2022-23 plus the £57k you contributed in 2023-24 will amount to less than 30% of the tax free cash.  (i.e. 44+57 < 30% x 336)

However if you retire in April 2024 but live off savings for a year and take your TFLS in April 2025, the 2022-23 contribution drops out of the analysis, so you will only need to take more than £190k tax free cash for the £57k 2023-4 contribution to be less than 30%.  (i.e. 57 < 30% x 190)

So, I recommend to be completely safe, you should postpone retirement until your tax free cash is greater than 3.3 times (i.e. 100%/30%)  your contributions in the previous two tax years (plus any contributions in the tax year in which you retire).  

Regardless of the above my guess is: if you are making the contributions on a salary sacrifice basis HMRC won't even look at applying these rules, because you will be able to argue that the contributions were not more than what might have been expected as they are made out of income, not savings or loans.

Thanks for asking this question as I have a close relative in a similar situation but I had not taken the trouble to investigate the rules previously.

Pat38493

[Deleted User] said:

The knowledge required is that you would get a bigger PCLS by making more contributions than you would otherwise do absent the extra tax-free lump sum.  Whether you know there are anti-avoidance rules is irrelevant.  It's a bit like driving. You know that if you put down you will go faster.  Whether you know what the speed limit is doesn't affect whether you will get a speeding ticket.

I'm not a lawyer, but I don't see it the same because when you are driving a car, there is no rule that the police has to prove that you pre-planned your intention to go over the speed limit before you exceeded it, so it doesn't seem like the same thing to me.

Thinking back to 2020, I was aware that when you retire you can get some tax free cash, but I wouldn't have known the details how the system worked - I think I came here asking dumb questions like - can you only take TFC once and can you take TFC every year and so on.  

NoMore

I think you are overthinking it, but you are not going to get anyone to give you a cast iron guarantee that HMRC won't investigate or do anything about it.

I've said before, I believe these rules are in place to stop firms advising people to do this, and making money from it, not to punish a individual. Its much easy to prove somebody was advised to do this, as that's preplanning covered right away. However I am not HMRC so cannot say how they will look at any individuals case.

Pat38493

Andreg said:

I am not a financial adviser.  According to Royal London, the five year period that HMRC look at is defined as follows:

• the tax year in which the tax-free cash was taken,

• the two tax years before the tax year that the tax-free cash was taken, and

• the two tax years after the tax year that the tax-free cash was taken

So, if tax-free cash was taken in tax year 2024/25, the testing period would be from 2022/23 to 2026/27.  Assuming you retire in April 2024, earn nothing after that, if you take more than £336k tax free cash then the £44k you contributed in 2022-23 plus the £57k you contributed in 2023-24 will amount to less than 30% of the tax free cash.  (i.e. 44+57 < 30% x 336)

However if you retire in April 2024 but live off savings for a year and take your TFLS in April 2025, the 2022-23 contribution drops out of the analysis, so you will only need to take more than £190k tax free cash for the £57k 2023-4 contribution to be less than 30%.  (i.e. 57 < 30% x 190)

So, I recommend to be completely safe, you should postpone retirement until your tax free cash is greater than 3.3 times (i.e. 100%/30%)  your contributions in the previous two tax years (plus any contributions in the tax year in which you retire).

Regardless of the above my guess is: if you are making the contributions on a salary sacrifice basis HMRC won't even look at applying these rules, because you will be able to argue that the contributions were made out of income, not savings or loans.

Thanks for asking this question as I have a close relative in a similar situation but I had not taken the trouble to investigate the rules previously.

Thanks - well I'm not sure the purpose of the rules is to force people to postpone a planned retirement.  Weirdly, if I had known about the recycling rules in detail in 2020, I might have increased my pension contributions by lesser amount to be safe, so weirdly the fact that I am technically breaching the headline limit proves that I was not aware!

The other thing though is that the rules are presumably a theoretical trigger on which HMRC might choose to investigate further - since they then have to prove pre-planning, they would have to investigate your situation in detail.  There are also examples in the HMRC website that shows for example that if you have variable income (bonuses etc) this is a valid reason for increasing your contributions (which by the way also applies in my case), and also you can consider inflation as part of the reason (high recently).

Also guidelines are not law - if a case ever came to court about this, I assume it would be the actual letter of the legislation that the court would consider and not the guidelines on a web site.

Andreg

My guess about these rules not being applied to salary-sacrifice was incorrect.  See example 5 in the HMRC manual:

PTM133850 - Unauthorised payments: deemed or specific situations that are unauthorised payments: recycling of pension commencement lump sums: examples to illustrate when the recycling rule applies - HMRC internal manual - GOV.UK (www.gov.uk)

Pat38493

Andreg said:

My guess about these rules not being applied to salary-sacrifice was incorrect.  See example 5 in the HMRC manual:

PTM133850 - Unauthorised payments: deemed or specific situations that are unauthorised payments: recycling of pension commencement lump sums: examples to illustrate when the recycling rule applies - HMRC internal manual - GOV.UK (www.gov.uk)

I have read all the examples from HMRC already and you are right in general but, the example listed on that page is an example where the person deliberately arranged for a large bonus of £100K to be diverted into a salary sacrifice pension contribution whilst at the same time taking a £100K PCLS, so that is a much more easy case to prove for HMRC than regular monthly salsas contributions over multiple years where they have to show that the contributions were more than “what would otherwise be expected” taking into account all sorts of things like bonuses and so on, and they have to show that you planned it from the start of the chain of events.  As Marcon said in the first reply I am not clear how they can prove that unless you took official advice that put in writing that this was the reason you are doing it.

Also - most or all of the HMRC examples have wording like “the individual did this with the intention of using it to pay significant increased contributions” or other similar wording.