Sanity check on pension recycling rules (mixed DB/DC scheme: USS)

NickBFS

I am in USS, which is a hybrid DB/DC scheme. In the past 5 years, in addition to the standard contributions, I have made AVCs to my DC pension pot of approximately 13K/year (approximately 21% of my salary). In the two years preceding my retirement (when I will be taking my TFLS), I plan to increase my AVCs to around 28K/year (about 40% of my salary) or possibly a little more.

I understand that I will not be caught by the pension recycling rules as long as the additional contributions in the 5 year period around the taking of the TFLS do not exceed 30% of the TFLS. My understanding is that I will not be anywhere near that threshold but I wanted to double check whether my understanding is correct, specifically on these two issues:

1) AIUI, the additional contributions mean the difference between what would normally be expected and the actual contributions (rather than the total amount of AVCs). So, in my situation, where I have been making 13K/year AVCs for several years before, this would mean (28-13)*2=30K (and not 28*2=56K). Is that correct?

2) My default TFLS under the DB part of the scheme would be 97K. I intend to increase this to around 190K, either through commutation of some of the DB pension or through use of the DC pot (or a mixture of both). In that situation, AIUI, the relevant figure for the TFLS for the purposes of calculating whether the additional contributions are below the 30% threshold is the actual TFLS I take (i.e. 190K) rather than the default TFLS of 97K (therefore theoretically allowing me up to 63K AVCs rather than 29.1K before hitting the threshold). Again, is this correct?

Pat38493

You might want to have a read of this recent thread:
https://forums.moneysavingexpert.com/discussion/6493487/pension-recycling-am-i-over-worrying/p1

Unfortunately the pension recycling guidelines are a bit of a grey area, partly because of the point you raise that the contributions should be compared to "what would otherwise be the case" and if an HMRC officer wanted to investigate it, the question would arise whether the increase in pension contributions to 28K was part of a deliberate plan to recycle tax free cash, or whether it was actually part of "normal retirement planning".

Further, HMRC officer has to show that you pre-planned this intentionally to recycle tax free cash and the onus is on them to prove it rather than you to prove that it's not the case.

In any case I think your figures are broadly ok, since if you are not increasing the contributions by more than 30% of the total TFLS taken, and assuming the TFLS is all taken in a single transaction, you would pass this test and therefore be ok on all other counts.

Some of the posters here seem to think that HMRC don't really make any attempt to enforce these rules on individual investors and they only want to discourage large scale recycling by adviser companies, but HMRC has never given out any clear information about how they enforce this and FOI requests have been refused apparently.

NickBFS

Thanks. The main thing I want to check is that my understanding of the rules re calculating whether one is under the 30% of TFLS threshold are correct, so that I don't even have to consider issues of intention/pre-planning, etc... I think that I would be OK on this front too but, as you say, it is a greyer area so, if I am OK on being below the threshold, then I don't have to think about the greyer stuff.  

Pat38493

NickBFS said:

Thanks. The main thing I want to check is that my understanding of the rules re calculating whether one is under the 30% of TFLS threshold are correct, so that I don't even have to consider issues of intention/pre-planning, etc... I think that I would be OK on this front too but, as you say, it is a greyer area so, if I am OK on being below the threshold, then I don't have to think about the greyer stuff.  

I think you are ok based on the figures you are posting - I am not familiar with this USS hybrid type scheme so the only other issue might be if the PCLS that you want to take ends up being done as 2 different payments for the part related to the DB and DC.  According to the examples used on the HMRC website, it's not the total amount of TFLS in a tax year, but it's tested against one of them and not both if you've taken more than one tax free lump sum in the same year - at least this is what is implied in one of the examples I think (which doesn't make sense but that's what the example seems to imply).

I would hope that in your case, they would in any case consider it as a single amount if it's all done at the same time, but since they don't answer any further requests for additional detail even from IFAs, you have to make your own judgements.

NickBFS

It would be paid as a single amount.

ussdave

Unless I'm misunderstanding your post I don't see how recycling has anything to do with it.  You're just funding your pension with your salary before you retire, right?  Recycling would be when you draw some pension funds and this then allows you to increase your pension contributions thereafter.

NickBFS

ussdave said:

Unless I'm misunderstanding your post I don't see how recycling has anything to do with it.  You're just funding your pension with your salary before you retire, right?  Recycling would be when you draw some pension funds and this then allows you to increase your pension contributions thereafter.

Well, the whole chapter and verse is that I have a mortgage which has roughly 4 years left to run. I am currently on a 1.59% fix which ends in October 2024. At that point, there will be about £36K left on the mortgage. Rather than going for another fix (or stay on the bank's SVR), I intend to pay off the remaining £36K using savings in an ISA account. The part of my salary which I currently use for mortgage payments would then be used to increase my pension AVCs.

In so far as a good chunk of the TFLS would be invested, it cannot be ruled out that this could be construed by HMRC as recycling (using savings to pay off the mortgage so as to enable higher contributions and then using the TFLS to replenish the savings). In truth, I would still use the savings to pay off the mortgage regardless of the TFLS, so, in my mind, I am not using the TFLS to enable me increase my contributions but it cannot be entirely ruled out that HMRC might look at it another way, hence why I would prefer to make sure that I am below the 30% threshold to avoid any kind of possible argument with HMRC on this.

jamesd

HMRC have previously said that they have never used the rules on an individual and schemes are the target.

You aren't planning recycling so nothing to worry about anyway.

Your overall plan seems poor. You take savings with no tax relief to pay off the mortgage when instead you could pay those savings into a pension to get tax relief first. At least a 6.25% gain from the tax free cash if all done at basic rate. Assuming you're 55 you can get the PCLS without triggering the MPAA and promptly use it for the mortgage reducing. Extra contributions from savings or even credit card borrowing now may also mean that they fall outside the five year window.

From 55 you can also use the £7,500 of tax free cash per rolling 12 month period allowance to eliminate part of the issue, removing this from the calculation.

If you have a spouse you can take the tax free cash into a bank account in your name and gift it to them by transferring into theirs. Don't use a joint account. You can do this in advance with the pension contributions if the income tax and possible NI saving are OK.

Savings to pay off a mortgage would be an obvious thing to do at the end of a mortgage deal with higher interest rate pending and there's no prospect of HMRC acting against such routine sensible use of savings. 

Pat38493

NickBFS said:

ussdave said:

Unless I'm misunderstanding your post I don't see how recycling has anything to do with it.  You're just funding your pension with your salary before you retire, right?  Recycling would be when you draw some pension funds and this then allows you to increase your pension contributions thereafter.

Well, the whole chapter and verse is that I have a mortgage which has roughly 4 years left to run. I am currently on a 1.59% fix which ends in October 2024. At that point, there will be about £36K left on the mortgage. Rather than going for another fix (or stay on the bank's SVR), I intend to pay off the remaining £36K using savings in an ISA account. The part of my salary which I currently use for mortgage payments would then be used to increase my pension AVCs.

In so far as a good chunk of the TFLS would be invested, it cannot be ruled out that this could be construed by HMRC as recycling (using savings to pay off the mortgage so as to enable higher contributions and then using the TFLS to replenish the savings). In truth, I would still use the savings to pay off the mortgage regardless of the TFLS, so, in my mind, I am not using the TFLS to enable me increase my contributions but it cannot be entirely ruled out that HMRC might look at it another way, hence why I would prefer to make sure that I am below the 30% threshold to avoid any kind of possible argument with HMRC on this.

I would be highly surprised if HMRC tried to challenge this, and in any case as you point out in your OP, it doesn’t breach the 30% of PCLS amount rule anyway, so even if they did it would still pass.  

Also if you look on that other thread I linked, there is a link to an article from an AJ Bell expert where it pretty much says that using a the lump sum to pay off a mortgage and then increasing your contributions is ok as long as you keep a record that the lump.sum was earmarked to pay off the mortgage.

Pat38493

jamesd said:

HMRC have previously said that they have never used the rules on an individual and schemes are the target.

You aren't planning recycling so nothing to worry about anyway.

Your overall plan seems poor. You take savings with no tax relief to pay off the mortgage when instead you could pay those savings into a pension to get tax relief first. At least a 6.25% gain from the tax free cash if all done at basic rate. Assuming you're 55 you can get the PCLS without triggering the MPAA and promptly use it for the mortgage reducing. Extra contributions from savings or even credit card borrowing now may also mean that they fall outside the five year window.

From 55 you can also use the £7,500 of tax free cash per rolling 12 month period allowance to eliminate part of the issue, removing this from the calculation.

If you have a spouse you can take the tax free cash into a bank account in your name and gift it to them by transferring into theirs. Don't use a joint account. You can do this in advance with the pension contributions if the income tax and possible NI saving are OK.

Savings to pay off a mortgage would be an obvious thing to do at the end of a mortgage deal with higher interest rate pending and there's no prospect of HMRC acting against such routine sensible use of savings. 

Do you have any source for your first statement in bold?  I’ve seen plenty of posts saying that it’s been kind of hinted by HMRC that this is the case, but I haven’t seen anything concrete that they definitively stated that they do not pursue individual taxpayers regarding recycling.

If this is written in black and white somewhere by HMRC it might alter my plans over the next 2 years as there are more aggressive things I could do that what I am planning right now.

ussdave

NickBFS said:

ussdave said:

Unless I'm misunderstanding your post I don't see how recycling has anything to do with it.  You're just funding your pension with your salary before you retire, right?  Recycling would be when you draw some pension funds and this then allows you to increase your pension contributions thereafter.

Well, the whole chapter and verse is that I have a mortgage which has roughly 4 years left to run. I am currently on a 1.59% fix which ends in October 2024. At that point, there will be about £36K left on the mortgage. Rather than going for another fix (or stay on the bank's SVR), I intend to pay off the remaining £36K using savings in an ISA account. The part of my salary which I currently use for mortgage payments would then be used to increase my pension AVCs.

In so far as a good chunk of the TFLS would be invested, it cannot be ruled out that this could be construed by HMRC as recycling (using savings to pay off the mortgage so as to enable higher contributions and then using the TFLS to replenish the savings). In truth, I would still use the savings to pay off the mortgage regardless of the TFLS, so, in my mind, I am not using the TFLS to enable me increase my contributions but it cannot be entirely ruled out that HMRC might look at it another way, hence why I would prefer to make sure that I am below the 30% threshold to avoid any kind of possible argument with HMRC on this.

I will defer to people that know more about this sort of thing but it really doesn't sound like pension recycling to me.  You're using non-pension savings to pay off your mortgage and then upping your pension payments with the linked reduction in mortgage costs.  For it to be considered under pension recycling rules you would need to draw a TFLS or PCLS first.

Again, unless I'm missing something, I don't think the considerations about what exactly constitutes 30% or whether or not HMRC are likely to take action apply here.  

From the HMRC site:

Recycling Recycling of a pension commencement lump sum involves using that lump sum as the means to increase contributions significantly to a registered pension scheme. The recycling rule is intended to prevent the systematic exploitation of the tax rules for registered pension schemes to generate artificially high amounts of tax relief by using the pension commencement lump sum to make a further, tax-relieved, contribution to a registered pension scheme.

https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm133810

Emphasis on "using the PCLS" and "make a further" contribution.

It would be an entirely different situation if you were drawing your pension first (say, with flexible retirement), using that money to pay off your mortgage, and then massively upping your contributions.  At that point the conversations above about HMRC apply.