Taking lumpsum and then contributing into pension - pension recycling ?

BlisteringBarnacles

Thanks for all the replies but it has only left me slightly more confused with regards to pension recycling rules. Let me answer the various questions raised one by one.

Part of the problem is uncertainty around my immediate future. I may be end up relocating to warm India within 1 to 2 years. I may not get a job in UK immediately. I have a health problem that seems to occur only in cold UK. Or my health problem may not occur in UK, I may get a job in UK and happily work for another few years. Lot of uncertainties ...

1) Why do I wish to take 250K lumpsum ? Long story. Feet and mind in 2 places : UK and India. If I end up in India, India does not recognize 25% lumpsum as tax free. So, since I am almost near the limit 268K, I figured may as well take the tax free cash lumpsum while I can in UK. (And no, I am not interested in QROPS for now).

Even ignoring my geographical / health uncertainties, this superbly articulated analysis in the bogleheads post below  gives a very good reason to take the lumpsum out once you hit 268K (at Pension pot 1.07 mill). Well I am not at 268K. But 250 is close. So for the sake of argument let me assume my 250 is actually 268. The thread is long but this particular post and indeed the same poster's very first reply are simply outstanding !
https://www.bogleheads.org/forum/viewtopic.php?p=7966009#p7966009

At the end of that thread, I have summarized my reasons for taking out 250K.

Pros : Taking the 250K cash free lumpsum will turn out to be a good decision if :
*) If I end up going to India for good fairly soon say in next year or two.
*) If tax rules change and the 25% is no longer tax free in UK
*) If I am in UK and I continue to be unemployed : If the 250K stays inside the pension pot, any growth will be eventually taxed as income (during drawdown). But if 250K is outside pension pot and moved to taxable, any growth is taxed at CGT/dividend tax rates and these are lower than income tax (Thanks to above bogleheads reply). Even if invested in bonds/money market, the dividends will be taxed at income tax rates, and if unemployed, these are low and certainly no worse than inside the pot where it may eventually attract 40% tax rates.
*) Taking the 250K out means I can invest the money soon and put it to work rather than sitting in cash as at present.

Cons: But Taking the 250K cash free lumpsum can be a sub optimal decision if :
*) If I find a job ( at 40% tax bracket) later this year. In this scenario the 250K lumpsum moved to taxable will attract CGT of maybe 20%, dividend tax of 33% or worse: bond income tax of 40%. OTOH If the money is left in the pension pot, perhaps I will eventually pay less than 40% tax during drawdown, if I take out 35-40K chunks per year. I looked at my state pension record and at current contributions I may get £172 a week (9K pa) going up to 11K pa if I contribute more. I may also get US social security of $700 a month.

But I cannot have it all. On the balance of probabilities, the pros seems to outweigh the cons. In my case it might be better to take the money out.

2) However I do NOT want to trigger MPAA just yet. Just want the lumpsum out.

3) PropertyGuru : Thanks for all the details. I dont know how HMRC will figure out "expected contributions" since I am not getting a salary at the moment.  However the 30% rule reassures me. 30 of 250K is 75K. I certainly cannot contribute more than 60K this year. Since half the year is almost over, in reality it will be much less, I may contribute at most 40K so I probably wont get into pension recycling issues. Am I thinking this correctly ?

4) westv : "To answer the question, you can contribute as much as you like to your pension up to the earnings and contribution limits. HMRC will have no interest in how this is funded." - really ? HMRC will have no interest in how this is funded ? I thought the whole point of pension recycling is that one cannot fund a pension contribution by using the taxfree cash lumpsum ? Taking an example : Let us say I take lumpsum out of £150K (in the hope of buying a Ferrari in near future) in Sep. In Oct I get a £120K job and do a salary sacrifice contribution of 59K from the salary, well within earnings and contribution limits of 60K. Clearly this is more than 30% of lumpsum (45K) - will HMRC consider this as pension recycling ?

5) That is why I asked if it is important to keep accounting records/trails separate so that I can prove that the lumpsum taken out is sitting in a separate bank/brokerage account or was used to buy said Ferrari and the new pension contributions are actually going in from new salary ?

Thanks a ton everybody !

Malthusian

It sounds like the 30% rule is your main protection against the recycling rules. Bear in mind that the recycling rules "take one year with another" so you could be caught if you paid a £60k contribution one year and another £60k the next, and it looked as if this was an increase of more than 30% over what would have been expected.

5) That is why I asked if it is important to keep accounting records/trails separate so that I can prove that the lumpsum taken out is sitting in a separate bank/brokerage account or was used to buy said Ferrari and the new pension contributions are actually going in from new salary ?

In itself this would not help. It does not matter whether the lump sum goes into one account and then goes out again to make the contribution, or if it goes into one account and the pension contribution goes out of another, while you use the first account to live off, if the contribution was more than 30% over what would have been expected.

If you already had a substantial amount in savings, which meant that you could have paid a £60k contribution even without taking the tax free lump sum, you might be able to argue that the £60k contribution would have been paid anyway and therefore wasn't "more than what would have been expected". The timing would still look a bit suspicious though. (Maybe the large contribution would not have been paid without taking the PCLS because you would have kept that cash as an emergency fund, or to spend on something else.)

Similarly, not being employed right this moment does not in itself mean that the pre-planning condition can't have occurred. "If I get a job paying enough income, I'll pay £100,000 into a pension, which I would be able to afford now I've got the PCLS" is still pre-planning.

Westv's post is wrong.

Pat38493 said:pension in their own name.

IFAs on this forum have stated in the past that there has never been a single court case about recycling up to now (which also means that no precedent has been set as the courts would look at the actual legislation in law rather than HMRC guidelines as a starting point).

The lack of court cases only tell us that nobody has fought HMRC all the way to the courts over tax free cash recycling.

If someone was accused by HMRC of recycling tax free cash and paid up, it would not enter the public record.

Equally, if someone was accused by HMRC, refused to pay up, and HMRC dropped the case before it went to court, again it would not enter the public record. 

Given that OP is almost at the lump sum allowance already, which means much of any contribution will be 100% taxable when withdrawn (except on death before 75), I wouldn't want to spend hours arguing with HMRC over it even if I eventually won.

westv

BlisteringBarnacles said:

4) westv : "To answer the question, you can contribute as much as you like to your pension up to the earnings and contribution limits. HMRC will have no interest in how this is funded." - really ? HMRC will have no interest in how this is funded ? I thought the whole point of pension recycling is that one cannot fund a pension contribution by using the taxfree cash lumpsum ? Taking an example : Let us say I take lumpsum out of £150K (in the hope of buying a Ferrari in near future) in Sep. In Oct I get a £120K job and do a salary sacrifice contribution of 59K from the salary, well within earnings and contribution limits of 60K. Clearly this is more than 30% of lumpsum (45K) - will HMRC consider this as pension recycling ?

You will have no issues. As far as anybody else is concerned you could have saved the lump sum and your other half was contributing to your pension from their savings.
You will be funding it from earnings. I would not try to tie yourself up in knots trying to work out the recycling rules! That's the simple answer despite others giving you paragraph after paragraph of answers. 

westv

Malthusian said:

Westv's post is wrong.

Pat38493 said:pension in their own name.

IFAs on this forum have stated in the past that there has never been a single court case about recycling up to now (which also means that no precedent has been set as the courts would look at the actual legislation in law rather than HMRC guidelines as a starting point).

The lack of court cases only tell us that nobody has fought HMRC all the way to the courts over tax free cash recycling.

If someone was accused by HMRC of recycling tax free cash and paid up, it would not enter the public record.

Equally, if someone was accused by HMRC, refused to pay up, and HMRC dropped the case before it went to court, again it would not enter the public record. 

I do feel that's a bit like the "elephant in the fridge".
My fridge has a device to prevent elephants stealing food
But there are no elephants around here.
Exactly!

BlisteringBarnacles

Thanks again everyone.
I have no family - no spouse, no kids.
I do have other savings : Taxable : {cash:100K, stocks:100K}, ISA : {cash:100K, stocks:300K}

So in my scenarios, it should be obvious that I will be contributing from earnings and not from the lumpsum. But then money is fungible and if HRMC is going to fantasize that all my money was for various "purposes" and it is only my lumpsum that funded the future pension contribution even tho I kept the accounting trail separate then I would have no answer. No one would.
Does it therefore mean that when you are working, you can never decide to { crystallize part of your pension pot, take the tax free lumpsum, go into deferred drawdown}  and still continue to work and make pension contributions ?

@Malthusian : I quote : Bear in mind that the recycling rules "take one year with another" so you could be caught if you paid a £60k contribution one year and another £60k the next, and it looked as if this was an increase of more than 30% over what would have been expected.
- I did not get this 60K, 60K 30% example. Could you please elaborate ?

How does HMRC make a call on what is "expected" ? For example in tax year 2020-21, 2021-22, 2022-23 I contributed 43K, 30K, 43K respectively via salary sacrifice. In 2023-2024 my income was low due to being off sick for several months, hence pension contribution was much less (22K). In 2024-25 so far it has been zero.

On another note, with age not on my side, almost 1 year gap and a slow market at the moment, who knows if I will even land a job ? I needed the break for personal reasons. Not sure employers care tho. However my ex colleagues are raking it in in contracting, so there is a (slim) chance I might land something really good. My interest in further pension contribution is to (1) contribute another 73K to get the 18K tax free cash lumpsum later (2) In case I happen to get a 100k+ salary then I might seriously consider pension contribution. (3) contribute enough to get employer match.

Perhaps I can contribute 30 to 40K - at least that would be "expected" from my past history.

PS : @Westv : your replies are reassuring and entertaining Cheered me up ! Cheers

Thanks again.

Pat38493

Malthusian said:

It sounds like the 30% rule is your main protection against the recycling rules. Bear in mind that the recycling rules "take one year with another" so you could be caught if you paid a £60k contribution one year and another £60k the next, and it looked as if this was an increase of more than 30% over what would have been expected.

5) That is why I asked if it is important to keep accounting records/trails separate so that I can prove that the lumpsum taken out is sitting in a separate bank/brokerage account or was used to buy said Ferrari and the new pension contributions are actually going in from new salary ?

In itself this would not help. It does not matter whether the lump sum goes into one account and then goes out again to make the contribution, or if it goes into one account and the pension contribution goes out of another, while you use the first account to live off, if the contribution was more than 30% over what would have been expected.

If you already had a substantial amount in savings, which meant that you could have paid a £60k contribution even without taking the tax free lump sum, you might be able to argue that the £60k contribution would have been paid anyway and therefore wasn't "more than what would have been expected". The timing would still look a bit suspicious though. (Maybe the large contribution would not have been paid without taking the PCLS because you would have kept that cash as an emergency fund, or to spend on something else.)

Similarly, not being employed right this moment does not in itself mean that the pre-planning condition can't have occurred. "If I get a job paying enough income, I'll pay £100,000 into a pension, which I would be able to afford now I've got the PCLS" is still pre-planning.

Westv's post is wrong.

Pat38493 said:pension in their own name.

IFAs on this forum have stated in the past that there has never been a single court case about recycling up to now (which also means that no precedent has been set as the courts would look at the actual legislation in law rather than HMRC guidelines as a starting point).

The lack of court cases only tell us that nobody has fought HMRC all the way to the courts over tax free cash recycling.

If someone was accused by HMRC of recycling tax free cash and paid up, it would not enter the public record.

Equally, if someone was accused by HMRC, refused to pay up, and HMRC dropped the case before it went to court, again it would not enter the public record. 

Given that OP is almost at the lump sum allowance already, which means much of any contribution will be 100% taxable when withdrawn (except on death before 75), I wouldn't want to spend hours arguing with HMRC over it even if I eventually won.

Ok but didn't the OP state that the TFC will be £250K and the additional pension contributions would be £60K.  That's not 30% of the TFC amount.  Therefore it wouldn't even be needed to pass the "contributions more than expected" test?

Also, in my opinion and obviously HMRC might try to disagree, once you reach the age where you have access to your tax free cash, your need for savings / emergency fund outside the pension is eliminated, or at least significantly reduced, precisely because you have access to that money quite quickly form the pension without tax consequences in the current tax year.

BlisteringBarnacles

Ok I must admit this is getting too complicated. The spirit of the law seems to be clear but the details are vague and open to the whims and fancies of HMRC. For the sake of More_complicated_than_that let me recap and I will try to be  brief. really appreciate your help.

1) Single, no family. Turning 56 in Oct this year. Resigned from last job Nov 2023 after working for 20 years. Right now on 1 year break. May or may not get a job.

2) Pension pot at £1 million. Have other assets (taxable 200K, ISA 400K). Wish to crystallize pension pot, take out 250K tax free lumpsum, not touch the remaining (i.e deferred drawdown). Lets not go into details of why. Short answer is I may relocate to India (sometime ... not sure when) and India does not recognize 25% tax free lumpsum, so I want to do it now that I am 55

3) After the above discussion my biggest worry now is : Even if I retire today and not contribute a penny more to pension, can I still fall foul of recycling rules if I take out 250K in September ? I ask because of my erratic contributions over last several years. All contributions were done thru "salary sacrifice", but sometimes I would get a bonus and just decide to put it into pension, sometimes I would contribute more if I felt insecure. Until my last day of employment there was certainly no "intention to recycle". I knew I was approaching 55. But I had planned to continue in my job. Due to sickness and family issues I could not continue working and quit. My last few years contributions thru salary sacrifice was :
Tax year : [2020-21 : 43K]  [2021-22 : 30K]  [2022-23 : 43K.] - So, high, Low, High
In 2023-2024 my income was low due to being off sick for several months, hence pension contribution was much less (22K).
In 2024-25 so far it has been zero.
- So, $64,000 question : If I take out 250K in Sep taxfree cash lumpsum, given the last few years contributions am I already at risk of being caught out for recycling ? If so, should I wait few more years before taking lumpsum ?

4) New job, new salary : Assuming I take out the lumpsum in Sep, If I do manage to get a job later this year or early next year, what is the max I can contribute via salary sacrifice in the new job to not breach recycling ? 20K per year ?

5) In the "30% of lumpsum" rule, should we consider cumulative contrubutions over few years ? So, 30% of my 250K is £75,000. So Should I stay under 75K per year or 75K over 2 years (37.5 K per year) in the 2 years in future AND 2 years in the past ? In 2021-22 and 2022-2023 I totalled 73K contribution so that is pretty close.

6) In the "30% increased contributions rule," compared to 2021-2022, there was a huge jump (more than 30%) in 2022-2023 but then I reduced in 2023-3024. The 30% rules are not clear.

7) For professional advice, should I go to a tax specialist ? Or are there pensions specialists who can spend an hour or two with me (not "manage" my pension for annual percentage of assets)?

Pat : I lost you on your last paragraph. If you could kindly reply that would be great.

Thank you all !!

Pat38493

Unfortunately you hit the nail on the head in your first paragraph - even when you read through all the examples, there is enough vagueness in the rules that no IFA is going to give you a devinitive answer.

3 - I am not an adviser or anything so it's just my opinion.  If I was in your situation I would not worry about this at all - I would certainly feel comfortable going ahead with it.

4 - Depends on how much you are earing, bonuses etc in the new job.  Again this is just my opinion, but HMRC guidelines states that this is not meant to prevent "normal retirement planning".  Personally I wouldn't worry unless I was contributing a lot more than 43K per year which is your prior pattern.  

5 - The examples imply that you would have to stay under £75K extra over the whole 5 year period (past and future), beyond what would normally have been expected.  Of course, what would "normally be exepcted" is the part that's open to argument, because it's part of "normal retirement planning" to increase your pensions contributions as you approach retirement, and in particular if you already have access to pensions.  Therefore HMRC and you would no doubt have a different view.

6 - My interpretation is that you have to look at it both cumulatively and individually depending on the situation - e.g. if you took out a 100K lump sum and then paid it all back in right away, and then argued that it was justified based on the prior two years, they might take a dim view on it.  HMRC examples state specifically that bonuses, inlfation, and pay rises can be taken into account.  What they don't state is whether decreasing outgoings (e.g. due to kids leaving home) can be taken into account i.e. if you have more disposable money to put into pension regardless of any lump sums taken.

7 - You would probably need to find an IFA who will give one off advice, but I am not sure whether they will give you a 100% definitive answer - they will probably just say the risk is low.

My view is that there is nothing in your post that I would feel uncomfortable proceeding on.  Further - I'm not sure I agree with Marcon that your statements that you "might" get another job later constitutes pre planning of recycling - I see that as a stretch since your posts imply that you are making various life decisions as you go along, and none of them seem to be primarily for the purpose of tax free reccycling.  Your comments about needing the TFC because you might be moving abroad is also a valid reason that has nothing to do with pre-planning of recycling.  In other words if I was you I would just go ahead on it.

My comment in the prior post on emergency funds would not be popular among tranditional financial advisers - what I am saying is that in the modern world, there are pension providers like II, where you can get your hands on your tax free cash within about 10 days or less.  As such, once you reach the age of 55 when you can access your pensions (soon changing to 57), I don't see any need, at least in my case, to keep a large emergency fund outside my pension if I have a lot of tax free cash availability inside the pension.  To me this is a valid retirement planning justification or running down your savings into your pension as you approach 55.

westv

I stand by what I said but would be interested to hear if any IFAs on here disagree and why.

leosayer

Will the presence of the tax free cash in any way enable you to make those planned pension contributions?

In other words, would your future pension contribution plans be the same if you didn't take the tax free cash?