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Considerations of recycling

What is considered recycling? What about the consequences of recycling? This article will look at what recycling is, what can happen if recycling takes place and how to avoid recycling.

What is recycling and why is there a rule about it?

There are many occasions where taking a pension commencement lump sum (PCLS) may be a legitimate exercise (because the underlying scheme has to come into payment with no deferral, because the lump sum is needed and planned to be used for some specific purpose such as new car, holiday, mortgage etc.) and under these circumstances there is no issue with taking this PCLS and using it. If there is then a surplus or if the client is still working and looking to fund a pension (maybe from another source) then this is not an issue and the recycling rules will not apply.

However, if the sole purpose of taking the PCLS is to “recycle” it back into a pension scheme to get more tax relief on the contribution, then this is not the legislative intention. The recycling rules were created so that individuals do not abuse the tax rules by using money they have received tax free from a pension, to make contributions that receive tax relief that they would not have otherwise made.

When dealing with a client who is taking a PCLS and making contributions into a pension or vice versa, you will need to consider whether your client’s actions are valid or will be classed as recycling.

What are the criteria for being considered as recycling?

The criteria for recycling are:

  • A client takes a PCLS of more than £7,500 (on or after 6 April 2015) or 1% of the standard lifetime allowance (before 6 April 2015). The value of the PCLS will also need to include any PCLS taken in the previous 12 months. Please see the explanation of this timescale below.
  • As a result of receiving this lump sum, the contributions are significantly higher than would otherwise have been made. As a rule of thumb more than a 30% increase would be a significant increase over the Timescale.
  • The contribution or contributions are more than 30% of the PCLS when combined over the Timescale.
  • The recycling is pre-planned.

What Timescale is it measured over?

When looking at recycling you are looking at a five year period. You first need to look at when a PCLS is taken and this becomes the middle tax year (you will need to add any other lump sums taken in the previous 12 months to arrive at the PCLS value used for the criteria above). You then need to look at the two tax years before that tax year and the two tax years after that tax year. Consequently if you take multiple lump sums you will need to do this calculation for each one.

For example if a PCLS was taken on 10 June 2014 (£10,000) and another one was taken on 10 April 2015 (£15,000), the timescale to look at for each assuming no other PCLS has ever been taken would be:

10 June 2014

  • Two tax years before are 2012/13 and 2013/14
  • Middle tax year is 2014/15 with total PCLS value of £10,000
  • Two tax years after are 2015/16 and 2016/17

10 April 2015

  • Two tax years before are 13/14 and 14/15
  • Middle tax year is 15/16 with total PCLS value of £25,000 (as you need to add any PCLS taken in the previous 12 months so £10,000 + £15,000)
  • Two tax years after are 16/17 and 17/18

What is pre-planning?

Pre-planning is where an individual intentionally takes a PCLS in order to increase their pension contributions. It does not matter in what order this happens. For example, your client could increase contributions with the knowledge that they will subsequently take a PCLS from their pension to cover the cost of the contribution or your client could take the lump sum for the purpose of increasing contributions. Both could be classed as pre-planned recycling. Where a dispute between an HMRC officer and the individual occurs, the onus to prove pre-planning is on HMRC.

What would the pension look like after recycling?

Here is an example of what this would look like:

  • Pension fund - £100,000
  • PCLS – £25,000
  • Remaining fund £75,000
  • Contribution of £25,000 net/£31,250 gross
  • New pension fund value - £106,250 of which £75,000 is crystallised and £31,250 is uncrystallised
  • The pension pot is now £6,250 higher in value however the available PCLS is £7,812.50 as opposed to the initial PCLS of £25,000.

If a client decides to recycle a PCLS the pension fund left will have a higher value but your client will have less tax free cash available. For someone that tax free cash is important to, for instance if they needed the money to pay off a mortgage, this may not be an ideal exercise.

What happens if your client is deemed to have recycled?

If the recycling is triggered, some or all of the PCLS will be classed as an unauthorised payment. This will mean an unauthorised payments charge, possibly an unauthorised payments surcharge, and a scheme sanction charge are due.

When wouldn’t the recycling rules apply?

There is no recycling if you:

  • Make sure any contributions made over that five year period (discussed above in timescales) do not exceed 30% of any cumulative pension commencement lump sums in that period.
  • Make sure there is not more than a 30% increase in contributions to what would normally be expected.
  • Consider increasing contributions into a spouse’s pension instead.
  • Wait until after the timescale considered has passed before making extra contributions.
  • Are making significant increases to contributions, make sure any cumulative pension commencement lump sums taken within the time frame do not exceed £7,500.
  • There is no pre-planning.

As explained in the second link below it is not recycling if there is no pre-planning. For example, your client could retire with a final salary pension, of which part of the benefit is a PCLS which cannot be exchanged for a higher scheme pension even though the client does not want the PCLS. If they then decided to use this PCLS to fund a personal pension, this would not be recycling as the PCLS was not taken with the intention to increase contributions.

  • Small pots do not produce a PCLS, although, if taken from an uncrystallised fund, 25% of the payment is tax free. Therefore if the only lump sum taken is the result of taking small pots, recycling cannot be triggered.
  • A standalone lump sum is not classed as a PCLS so recycling cannot be triggered.

Do you have any useful links with examples?

  1. The following shows examples of when recycling applies –
  2. The following shows examples of when recycling does not apply –
  3. The following is an explanation of what pre planning is –

The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth's interpretation of the relevant law and is correct at the date shown on the title page. While we believe this interpretation to be correct, we cannot guarantee it. Old Mutual Wealth cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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