With rumours circulating that the Chancellor may restrict the amount of tax-free cash people can take from their pensions in the upcoming Budget, people may rush to take the money now in the belief that they can reinvest it back into their pension if the change does not happen. However, they risk falling foul of pension recycling rules that will land them with a nasty tax charge, says Helen Morrissey, head of retirement analysis, Hargreaves Lansdown.
Rumours around tax-free cash continue to swirl with concerns it may prompt people to take the money before the Budget happens. Some people will have a plan for that cash – for instance to pay off a mortgage or carry out home renovations, but there will be others who are doing it as a knee jerk reaction, and this comes with risks.
One approach people may think they can take is to take the tax-free cash now and then if the change doesn’t happen, just reinvest it back into their pension. However, doing this could put them at risk of breaching pension recycling rules which could see them clobbered with a hefty fine of up to 55%. It’s also worth saying HMRC recently clarified that people would not be able to put in a request for their tax-free cash and then cancel it should the announcement not be made.
Pension recycling is deemed to have happened when someone has taken their tax-free cash and recycled it into their pension for the purposes of receiving artificially high tax relief. For pension recycling to have happened ALL of the following conditions need to have been met:
- The individual receives tax-free cash from their pension.
- Because of this, the amount of contributions paid into the pension scheme is significantly greater than it otherwise would be. HMRC will look at contributions in the tax year the tax-free cash is taken and the two tax years either side to determine this.
- The additional contributions are made by the individual or by someone else, such as an employer.
- The recycling was pre-planned. This is something that HMRC needs to establish, and it can prove very tricky. This planning must have happened either before or at the time the tax-free cash was taken, not after.
- The amount of tax-free cash, taken together with any other such lump sums taken in the previous 12-month period, exceeds £7,500.
- The cumulative amount of the additional contributions exceeds 30% of the tax-free cash.
The pre-planning condition is the area that causes the most confusion. It has to be proven that the person planned to use tax-free cash either directly or indirectly to boost their pension contribution to get extra tax relief.
An example here could be taking out a loan to pay the increased contribution and then using tax-free cash to repay it. HMRC says that each case is to be decided on its own merits so it’s difficult to outline cases that would definitely result in HMRC saying pre-planning hadn’t taken place.
In theory people can continue funding their pension without needing to worry about falling foul of the recycling rules provided not all of the above conditions are met. However, it’s extremely complex and people should consider speaking to a financial adviser if they wish to continue contributing to their pension to make sure they don’t inadvertently break the rules.
Main image: christopher-bill-rrTRZdCu7No-unsplash-
