Taking lumpsum and then contributing into pension - pension recycling ?

Malthusian

westv said:

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!

If there were explicit civil penalties for feeding wild elephants in the UK, and nobody had ever been taken to court for feeding elephants and refusing to pay the fine, I wouldn't argue "nobody has ever got in trouble for feeding elephants, therefore nobody will care if you do it".

BlisteringBarnacles said:

- 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 ?

No, because your post establishes that the "pre-planning" condition hasn't been met. The onus is on HMRC to prove that "pre-planning" occurred and that you intended to fund the contributions with tax free cash at the time you took the tax free lump sum, or at the time you made the contributions, depending on which came first.

If you make a salary sacrifice contribution (which itself raises the bar for proving pre-planning as it is by definition coming out of your earned income) and you remain able to afford your current lifestyle, with no gap in your finances which has to be plugged by taking the tax free cash, there is no pre-planning.

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 ?

It's whatever you would have contributed if you hadn't taken the tax free cash (subject to the other thresholds).

 5) In the "30% of lumpsum" rule, should we consider cumulative contrubutions over few years ? 

Yes.

HMRC said: 
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:

• 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

I wouldn't personally ask a specialist for advice on this (who will not be able to give you a definitive answer anyway) because at the moment you are at essentially zero risk of being caught by the tax free cash recycling rules if you draw your tax free lump sum now, and the idea that you might be in future depends on hypotheticals. 

Malthusian

Pat38493 said:

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. 

A bit of a tangent, but if my pension pot was with Ayayay or any other shoestring DIY provider, I would definitely have a very substantial emergency fund and would not count on being able to access any part of my pension fund at will. 

The regulatory requirements to send reams of questionnaires and risk warnings if you withdraw from your pension means that expecting to get your hands on tax free cash within 10 days is very optimistic. Some providers interpret the regulations and are more efficient at processing the questionnaires than others - but I wouldn't rely on them continuing to do so.

Pat38493

Malthusian said:

 The onus is on HMRC to prove that "pre-planning" occurred and that you intended to fund the contributions with tax free cash at the time you took the tax free lump sum, or at the time you made the contributions, depending on which came first.


It's whatever you would have contributed if you hadn't taken the tax free cash (subject to the other thresholds).

 

The first point is the key one - in the situation described, HMRC would have to take the view that you made the plan to recycle the tax free cash, at the time you made those first 43K of contributions 2-3 years earlier.  Since you state that this is not the case, I assume it would be impossible for them to show it.

"It's whatever you would have contributed if you hadn't taken the tax free cash (subject to the other thresholds)."

Plus 30%?    At least, the guidelines state that they would not even normally look at it unless the contributions beyond "what would otherwise have been expected" are > 30%.  Therefore in the case of a 250K lump sum, he could contribute an extra £75K beyond what he would have normally done, cumulatively  over the current and following 2 years (subject to other thresholds as you say).  Interestingly, if it was for example a minimum wage job, this would imply OP could put almost all their salary into the pension even if they had not made any contributions in the prior 2 years!

As I understand it (?) all of the tests have to be passed before it's considered recycling, so even if the contributions were 30% more than expected, it doesn't matter because the additional contributions are less than 30% of the TFLS taken?  As long as you pass one test you are ok?

Organgrinder

I had this dilemma but with much smaller sums of money.

In the end it comes down a very basic question imo. If you fund any contributions from income and can demonstrate that the lump sum is still there HMRC would have one hell of a job proving you've recycled the money. 

It took me ages to realise this! My lump sum was going to pay the mortgage off. But at 1.64% fix I'm better off earning interest on it. So my lump sum is still there. I've increased my pension contributions past the point at which technically I'm breaking recycling rules.

But. It wasn't preplanned and the extra is funded solely from increases in my income. (I am on a phased retirement and my pension income puts my total take home up by roughly £500 a month, all of which goes into my pension and is considered normal retirement planning).

BlisteringBarnacles

thanks for the detailed replies all ! Much appreciated. Certainly reassuring that what I plan to do is probably going to be ok. But I dont know ...Because of the vagueness surrounding the rules, I am still apprehensive about taking the lumpsum out which I want to. if HMRC sends me a letter accusing me of recycling then I am going to get screwed....

Future contributions are within my control. a) I will contribute only if I get a job and earn a sufficiently high income. b) Even then I may limit contributions to 20K or so so I dont get into trouble.

But I cant go back in time and change my past contributions. Given that they were erratic (40K, 30K etc) I am not sure what trouble I will get into by pulling out 250K now.

Best would to get some professional advice so I can sleep well. IFAs are not helpful unless you give them a percentage of your assets. No, I dont want to pay £20,000 just to answer this pension recycling question. I can certainly pay few hundred pounds tho. I can give them the complete history of contributions. Perhaps a good tax advisor can answer because it is kind of an HMRC/Tax question ?

Thanks

Pat38493

BlisteringBarnacles said:

thanks for the detailed replies all ! Much appreciated. Certainly reassuring that what I plan to do is probably going to be ok. But I dont know ...Because of the vagueness surrounding the rules, I am still apprehensive about taking the lumpsum out which I want to. if HMRC sends me a letter accusing me of recycling then I am going to get screwed....

Future contributions are within my control. a) I will contribute only if I get a job and earn a sufficiently high income. b) Even then I may limit contributions to 20K or so so I dont get into trouble.

But I cant go back in time and change my past contributions. Given that they were erratic (40K, 30K etc) I am not sure what trouble I will get into by pulling out 250K now.

Best would to get some professional advice so I can sleep well. IFAs are not helpful unless you give them a percentage of your assets. No, I dont want to pay £20,000 just to answer this pension recycling question. I can certainly pay few hundred pounds tho. I can give them the complete history of contributions. Perhaps a good tax advisor can answer because it is kind of an HMRC/Tax question ?

Thanks

If this happens, based on what you have explained, you should appeal and challenge it as there is no way that it was pre-planned, and in any case you are within the tolerance.  Your prior contributions would only be an issue if you had formed a per-plan to recycle tax free cash before you set those contributions up in the past years.

Erratic contributions are covered in one of the HMRC examples on their website and they say this is perfectly fine and expected (e.g. if you have variable bonuses).

Further - I doubt HMRC are remotely interested in what you are doing because in reality, the amount you could recycle would be pretty limited by the fact that you are already quite close to the 268K threshold for generating tax free cash, so even if you were deliberately recycling, you would very quickly face a rule of diminishing returns.  

Keep in mind that as an individual, the amount you could theoretcially recycle even if you were completely ignoring the rules, would be reduced by a factor of 4 on each "cycle" of the process, so the real gains to most taxpayers from doing this are probably less than what it would cose HMRC to investigate it.

NoMore

Pat38493 said:

Keep in mind that as an individual, the amount you could theoretcially recycle even if you were completely ignoring the rules, would be reduced by a factor of 4 on each "cycle" of the process, so the real gains to most taxpayers from doing this are probably less than what it would cose HMRC to investigate it.

It makes me wonder why they even bothered worrying about recycling in the first place, as you say its diminishing returns.

leosayer

NoMore said:

Pat38493 said:

Keep in mind that as an individual, the amount you could theoretcially recycle even if you were completely ignoring the rules, would be reduced by a factor of 4 on each "cycle" of the process, so the real gains to most taxpayers from doing this are probably less than what it would cose HMRC to investigate it.

It makes me wonder why they even bothered worrying about recycling in the first place, as you say its diminishing returns.

The way the Pensions Tax Manual is written makes me think that it is targeted at financial advisors that provide advice and services (loans etc.) that encourage recycling.

"The recycling rule is intended to prevent the systematic exploitation of the tax rules..."
"...where those lump sums are used as part of a recycling device..."
"...through to the use of any devices, schemes, arrangements and understandings of any kind..."

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

FIREDreamer

NoMore said:

Pat38493 said:

Keep in mind that as an individual, the amount you could theoretcially recycle even if you were completely ignoring the rules, would be reduced by a factor of 4 on each "cycle" of the process, so the real gains to most taxpayers from doing this are probably less than what it would cose HMRC to investigate it.

It makes me wonder why they even bothered worrying about recycling in the first place, as you say its diminishing returns.

You have a pot of £512k.

You take tax free cash of £128k.

(1) You pay £128k gross back into a pension (assuming earnings and carry forward can support).

You take tax free cash of £32k from this.

(2) You pay £32k gross back into a pension (assuming earnings and carry forward can support).

You take tax free cash of £8k from this.

(3) You pay £8k gross back into a pension (assuming earnings and carry forward can support).

You take tax free cash of £2k from this.

(4) You pay £2k gross back into a pension (assuming earnings and carry forward can support).

You take tax free cash of £500 from this.

(5) You pay £500 gross back into a pension (assuming earnings and carry forward can support).

You take tax free cash of £125 from this.

And so on …

As can be seen, the tax free amounts drop off quite quickly.

Instead of £128k tax free cash you get tax free cash of £128k + £32k + £8k + £2k + £500 + £125 + £31.25 + …

Total is £170,667 or 33.33% of the original pot. Or 25% of £512,000 + £170,667.

BlisteringBarnacles

Forgot to say thank you. Thanks to all for the detailed clarifications. I got distracted with some personal work and did not check this thread.

I am going to make a table of all the contributions over the last several years. I have my all my paystubs. The yearly amounts I mentioned may be off by a few thousand quid.

Thanks