Pension Fund Recycling Explained
Published / Last Updated on 17/05/2021
Recycling Pension Funds Into New Pension Cap.
Currently, the maximum both you and your employer can pay into a pension each tax year in total is £40,000 gross. This is known as the Pension Annual Allowance.
Combining the above with the new flexible pension laws that started in April 2015, presented the Treasury with something of a dilemma.
Pension Recycling Explained
The scenario was: You pay into pension funds e.g, £40,000.
You then retire or drawdown from this fund next year.
£10,000 Tax Free Lump
£30,000 Taxable Drawdown and withdraw it all. If this is your only income in that tax year, it is taxed at 20% as follows:
- First £10,000 is within personal allowance = NIL tax
- Remaining £20,000 is taxed at 20% = net income £16,000.
Total money in hand: £10,000 lump sum + £26,000 net drawdown = £36,000.
Let us now say you start working again, reinvest most of the money received above, e.g. £33,333 (which is below the maximum annual pension contribution allowance cap of £40,000).
Net contribution £33,333 + Tax Relief 20% Basic Rate = £40,000 Total Gross Money in Pension Fund now.
The pension recycling dilemma: You started with £40,000 in your pension fund and by retring from the scheme and recycling it back in (and claiming tax relief) you now have £40,000 in your pension fund and it has cost you nothing: Why?.
- Pension Fund Before £40,000. Pension Fund After £40,000
- Tax Paid £4,000. Tax Relief received £6,667.
- Money in your hand £2667 (£36,000 net drawdown less £33,333 contribution) AND YOU STILL HAVE £40K IN YOUR PENSION POT!
Loophole Closed
As part of the Taxation of Pensions Act which, included all the new pension flexibility rules, the Treasury has confirmed that for those who are over the age of 55 and have used pension flexible drawdown, the money purchase annual pension allowance will be capped at £10,000 and not £40,000 as it is for others.
In addition, if you solely withdraw the tax free cash lump sum and take no flexible income drawdown payments, you retain the full annual allowance of £40,000pa.
This, in simplistic terms caps and controls any pension recycling abuse.
Comment
Pension recycling cap will not affect that many people given that many of us do not contribute £10,000 per year into pensions let alone being in a position to recycle. That said, the move closes an obvious loophole although we can still see people recycling pension fund even up to the £10,000 level.
It will still cost the tax payer money, but the government are caught up between the need to protect tax revenue and the need to encourage people to save greater numbers in their pension funds.