Tax-free cash recycling

These FAQs are for financial advisers only. They must not be distributed to, or relied on by, customers. They are based on our understanding of legislation, at the date of publication.

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If the tax-free cash recycling rules didn’t exist, tax-free cash could be taken from a pension plan and re-invested back into a pension plan by paying it in as a contribution. Tax-relief would be available on the contribution up to 100% of relevant UK earnings (or £3,600, if greater).  As well as benefitting from tax-efficient growth, generally, the individual could either take another tax-free cash amount of 25% of the fund (limited to 25% of their remaining lifetime allowance) and take the rest as income (subject to tax at their marginal rate) or take an Uncrystallised Funds Pension Lump Sum (25% tax-free with the remaining lump sum subject to tax at the individual’s marginal rate.) 

As you can imagine, HMRC aren’t happy with the possibility of an individual gaining twice (or even more times) from the tax-advantages of a pension, so tax consequences are imposed on those who meet the conditions for tax-free cash recycling. This FAQ gives further details on this.

There are conditions, all of which need to be present, for tax-free recycling to have taken place. The three requirements are:

  1. The recycling is ‘pre-planned’.
  2. The tax-free cash taken, either alone or in aggregate with other tax-free cash amounts taken in the previous 12 months, must be more than £7,500.
  3. There is a ‘significant increase’ in the level of expected pension contributions (personal, employer and third party contributions) to any one or more registered pension schemes because of the tax-free cash taken, or to be taken.  For this condition to apply, both of the following must be present:

a) There is an increase of more than 30% of the contributions that might have been expected, based on a number of factors, such as contribution history and current contractual rate of contributions, and

b) the increase in contributions is more than 30% of the tax-free cash amount that the member took

Only if all these above conditions are met, is the tax-free cash amount classed as an unauthorised payment and taxed accordingly.

Pre-planning is where the individual makes a conscious decision to take the tax-free cash in order to allow significantly increased contributions whether directly or indirectly to be paid to a registered pension scheme by or for them. 

Pre-planning must take place at a ‘relevant time’ as described by HMRC. Where the tax-free cash is taken before contributions are significantly increased, the ‘relevant time’ is when the tax-free cash is taken, and where the significant increase in the level of expected contributions are  first made then the ‘relevant time’ is when the increase to the contributions takes place. 

Where an individual takes tax-free cash and only later decides to use it to pay greater contributions, the onus will not be on the individual to prove the absence of intent to recycle. HMRC can, however, take into account any evidence that points towards pre-planning.

The significant increase is carried out on a cumulative basis in order to prevent someone avoiding the rule by increasing contributions on a piecemeal basis, or gradually over time. 

The period of time over which the measurement to determine a significant increase will take place is:

  • the tax year in which the tax-free cash is taken with an intention to use it to significantly increase contributions, and
  • the two immediately preceding and two immediately following tax years (so where the tax-free cash is taken in 2018/19, the two preceding tax years would be 2016/17 and 2017/18 and the two following tax years would be 2018/19 and 2019/20)

This gives a five year testing period. 

Any personal contributions (including third party contributions but excluding employer contributions) which are paid on or after age 75 are excluded from this test. This is because personal contributions do not attract tax relief and therefore the member will not benefit from double tax-relief if recycling occurs. 

With regards to measuring whether there has been a significant increase in contributions, where the member hadn’t paid contributions in a while, the Retail Price Index (RPI) can be used to up-rate the last contribution to produce a current value for comparison purposes. Contributions paid that are within the five year testing period should not be uprated.

Where it is an aggregate of tax-free cash amounts that takes the amount over the £7,500 limit, it is the last payment of tax-free cash that the significant increase in contributions is measured against.

There is no definitive list of situations that will be caught by the recycling rules, but the following are some examples of situations that will be caught:

  • Paying the tax-free cash as a contribution (where the three rules are all met)
  • Borrowing to facilitate recycling (where it is intended to repay the loan with the tax-free cash)
  • Employer contribution facilitating recycling (usually where the individual can control the level of employer contributions)

The following are some examples of situations in which the recycling rules may not apply:

  • The member receives an inheritance soon after taking the tax-free cash, and because of the inheritance they make a one-off contribution
  • Contributions are based on profits from self-employment
  • The member benefits from a genuine windfall and takes a tax-free cash sum, the payment of which had been under way before the win, to clear debts before receiving the windfall. When the windfall is received, the member pays a contribution to a registered pension scheme
  • The employer buys an immediate annuity for an employee whose employment had been non-pensionable, and the employee takes a tax-free cash sum from a scheme they had been privately funding

A member who takes a tax-free cash sum with the intention of recycling it will have to tell the scheme administrator of the recycling within 30 days of the date of the deemed unauthorised payment. 

Where the member fails to tell the scheme administrator within the required 30 days, the member could be liable for a penalty of up to £300. Subsequent penalties of up to £60 a day could become payable for as long as the member doesn’t inform the scheme administrator. 

The member should also declare the unauthorised payment on their self-assessment tax return.

The whole tax-free cash amount (not just the amount that is deemed to have been paid in additional contributions) is an unauthorised member payment. 

The unauthorised member payment is deemed to occur when all the conditions for recycling rules to apply are met. This date will determine the year of assessment in which the charge arises. 

Where the significant increase in the contributions happens first, it will be the date of the payment of the tax-free cash that is the deemed occurrence date. 

Where the tax-free cash is taken before the significant increase in contributions happens it will be the date that those significantly increased contributions are made that is the deemed occurrence date. 

Member tax charges:

The member will be liable for:

  • An unauthorised payments charge of 40% of the tax-free cash amount
  • A possible further 15% surcharge where the unauthorised payment either alone or in aggregate with any other unauthorised payment to, or in respect of the member from that registered pension scheme over a 12 month period is 25% or more of the member’s total rights under the scheme

As it is common for the tax-free cash element of an arrangement to be taken at 25% level, if tax-free cash recycling is deemed to have occurred, the surcharge is likely to apply in most cases. 

Scheme administrator charges:

The scheme administrator will be liable for a scheme sanction charge of between 15% and 40% of the tax-free cash amount (dependent on the amount of charge actually paid by the member).

The scheme administrator can, where it considers that it has just and reasonable grounds to do so, ask HMRC to discharge its scheme sanction charge liability. Such a request can be made, for example, where a member triggers the recycling rule despite having previously told the scheme administrator that they had no intention of doing so.

The recycling rules are not limited to individuals in a registered pension scheme who are UK resident. The rules also apply to non-UK residents in a UK registered pension scheme. 

They could also apply where:

  • An individual takes tax-free cash from a registered pension scheme then recycles it into an overseas pension scheme where UK tax relief is available on contributions as if the overseas pension scheme were a registered pension scheme, or
  • An individual benefiting from migrant member relief (i.e. an individual who has come to the UK and received UK tax relief on contributions to their existing overseas scheme, subject to conditions) recycles a tax-free cash payment from an overseas pension scheme into that same scheme or to a UK registered pension scheme

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