PENSIONS - 29.11.2012

How to beat the lower pension recycling limit

Recycling (reinvesting) your pension lump sum is a simple way to boost the value of your retirement nest egg, but it’s subject to limits which were reduced in April. So how do you now maximise the recycling tax break?

What is pension recycling?

Simply put, recycling is taking the tax-free cash lump sum from your pension, available from age 55, and reinvesting it into another pension on which you’ll receive further tax relief. Effectively, you’re doubling your tax relief on the same money. In fact, before the Taxman jumped on this neat scheme you could recycle pension tax-free cash a few times to produce a truly awesome tax break.

Reduced limit

To counter this the Taxman placed an £18,000 limit, and some other restrictions, on the amount of pension tax-free cash you could recycle. From April 6 this was reduced to £15,000. But not many people realise there are opportunities for recycling beyond this. These higher levels of recycling are allowed where:

  • on aggregate in the two years before or after you take your tax-free cash you reinvest no more than 30% of this amount (see The next step)
  • the amount reinvested per year doesn’t exceed your original normal pattern of pension contributions by 30% (see The next step)
  • you haven’t planned the recycling before you took your tax-free cash. Note. It’s up to the Taxman to prove this.

Trap. If all the conditions are broken a tax charge equal to 55% of the amount recycled will apply.

Tip. If you’re prepared to wait more than two years after taking your tax-free cash, the recycling anti-avoidance rules won’t apply.

The value of recycling

To give you an idea of how much recycling can be worth, the table below shows how much extra tax relief you can get even where you stay within the Taxman’s minimum recycling limit.

Pension fund age 55, say £150,000
Tax-free cash (max 25%) £37,500
Reinvested (recycled) £15,000
Extra tax relief if you pay 20% tax £3,000
Extra tax relief if you pay 40% tax £6,000
Extra tax relief if you pay 50% tax £7,500

If you don’t have an immediate need for the tax-free cash, and you’re expecting to have a reasonably long retirement, recycling seems to us like an offer you shouldn’t pass up.

Pension recycling

The good news is that recycling doesn’t have to end with the tax-free cash payment. It’s possible to “draw down”fromyour pension fund and reinvest (recycle) this into a new pension plan. What’s more, the anti-recycling rules don’t apply to this.

Example. Jenny is a company director who’s just turned 55. Her pension fund is worth £250,000, and she earns £90,000 per year. She takes the maximum tax-free cash (25%) of £50,000 and recycles just enough of this so as not to trigger the anti-avoidance rules. She also draws down £12,000 per year from the balance of the fund. After 40% tax she’s left with £7,200 to reinvest into another pension. The Taxman adds £1,800 tax relief to this, making £9,000. After five years, ignoring growth, the fund is worth £45,000 and Jenny can take 25% of this, i.e. £11,250 tax-free.

You can now recycle only £15,000 of your tax-free lump sum into another pension. But a higher amount is allowed as long as it’s no more than 30% of your lump sum and other conditions are met. Plus, you can draw on your pension fund and reinvest this immediately into a new pension to qualify for extra tax relief.

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