Tax-free cash recycling rules??

[MisterA]

Hi all,

This is a very UK specific topic. Does anybody have a good understanding of the UK tax-free cash recycling rules? They are complicated.
Recap:

• You can contribute up to £40k of your wages into your pension each year, or your full wages, whichever is the least. Income tax is not payable on these contributions.
• You can carry this allowance forward by three years, so that you can top up to the maximum £120k contributions over 3 years.
• When you retire, you can then take 25% of your pension savings tax-free.
• The financial year end is in April, and we’re in March. By carrying forward, I have some unused allowance. If I paid in £10k from my savings into a SIPP, the SIPP would be credited by £12.5k, due to the income tax refund.

So far, so good.

If I then FIRE’d any time after 05/04/23, I could withdraw the full £12.5k (or more up to the full 25% tax-free amount).

BUT the HMRC have something called the ‘tax-free cash recycling rules’, designed to stop people from using the tax-free cash (or Pension Commencement Lump Sum) to significantly increase pension contributions and gain additional tax relief. This could apply even if you pay the contribution before receiving any tax-free cash. The penalty is up to 70% of the value of the tax-free cash, so up to £8,750 on the £12,500 tax-free lump sum example above. So a huge penalty.

So the question is, if I pay for example £10k (so £12.5k after the tax rebate) into my SIPP now in March, then retire in April or May and take a cash-free lump sum of £12.5k (or more), am I breaking the tax-free cash recycling rules??

This is the HMRC page that gives information:
https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm133810

And a link to a Hargreaves Lansdown fact sheet:
https://www.hl.co.uk/__data/assets/pdf_file/0005/45428/Recycling_Factsheet.pdf

I’ve read these (and more), but it’s still not entirely clear to me, and I’m not sure where I could get advice.

[PhilB]

The rules are indeed complex and opaque.  As you presented it, what you propose would appear, prima facie, to get caught by the rules as you are suddenly bumping up your contributions and then taking tax free cash almost immediately.

Do you actually need to take all the tax free cash in one go?  Life is much simpler if you can go the UPFLS route and take the money out more gradually.  If you crystallise £29,996 a year then you are only taking £7,499 in TFLS each time (the balance being taxable) and the recycling rules can never be triggered.

Basically if you need to take it all back out again for cashflow reasons then that would seem very much to be recycling.  If you don't, then don't and the problem doesn't arise.

[cerat0n1a]

Does the problem go away as a result of the budget? I.e. could you just contribute £60K in one tax year anyway?

[LateStarter]

I am not a tax expert but this is my understanding:

The 'recycling' clause is only there to prevent you from taking money out of a SIPP only to then pay it back in = profit, ie. pay in £1k, withdraw £1.25k, pay in £1.25k, withdraw £1.56k, and repeat.
 
This can only be a concern (to the taxman) if you continue to contribute to your SIPP after you've started withdrawals.

if, once you retire and start SIPP withdrawals you no longer contribute to a SIPP, you are not recycling.

[PhilB]

The budget doesn't change anything on this one.  The Annual Allowance isn't relevant, they look for 'unusual' contributions in the year you take the tax free cash, the two years before and the two years after.  Unusual in this case just means compared to what you'd normally been contributing.

The rules are very specifically to stop you putting in just to take out again.

@LateStarter the rules cover contributions both before and after you take the TFLS.  'Before' covers cases like:

• Borrow £32k and put it into a pension - grossed up to £40k
• Retire and take the £40k straight back out - £10k tax free, £30k taxed - total £34k if you are already using your PA
• Pay off the loan and pocket the £2k profit

It applies 'After' as well because your future contributions are only restricted if you withdraw crystallised fund from a DC scheme.  With a DB scheme you could just take out all your AVCs tax free and never trigger the MPAA letting you recycle the full TFLS into a SIPP if this rule didn't exist.  With a DC scheme the rule is to stop you crystallisung the whole shebang, leaving the 75% untouched and recycling the 25%.

[LateStarter]

Yes, you're right @PhilB

Silly me - thinking tax rules might be straightforward . . . .

[PhilB]

Yes, you're right @PhilB

Silly me - thinking tax rules might be straightforward . . . .

It never ceases to amaze me how they expect 'normal' people to be able to understand and comply with the rules.  Thankfully the abolition of the LTA gets rid of many of the more egregiously awful ones :)

[MisterA]

Thanks all. I only became aware of these rules recently, nobody else has ever mentioned them and I hadn't read about them elsewhere. But, I'm glad that I did find out about them before executing my little scheme.

The 'recycling' clause is only there to prevent you from taking money out of a SIPP only to then pay it back in = profit, ie. pay in £1k, withdraw £1.25k, pay in £1.25k, withdraw £1.56k, and repeat.
 
This can only be a concern (to the taxman) if you continue to contribute to your SIPP after you've started withdrawals.

if, once you retire and start SIPP withdrawals you no longer contribute to a SIPP, you are not recycling.

I've read much more than the 2 links I gave, and I think that you're absolutely correct in this interpretation. My considered opinion is that I'd probably be OK. But:

Do you actually need to take all the tax free cash in one go?  Life is much simpler if you can go the UPFLS route and take the money out more gradually.  If you crystallise £29,996 a year then you are only taking £7,499 in TFLS each time (the balance being taxable) and the recycling rules can never be triggered.

Basically if you need to take it all back out again for cashflow reasons then that would seem very much to be recycling.  If you don't, then don't and the problem doesn't arise.

No we don't need the money, it has been taken from other reserves that MrsA would like to be replenished (just because she likes to know it's there) but that we don't 'need'.

I think we'll do as @PhilB suggests. Draw slightly less than the £7.5k tax-free initially, then just over 12 months later (maybe) draw the full remainder of the 25%. I think the HMRC would be hard pushed to suggest the recycling rules were broken in the 2024/25 tax year if the contributions were made during the 2022/23 tax year.

But initially I'll pay the money in, FIRE in a few months, draw £7,499, then think about the rest later.

I'm sure that topping up your allowance before retirement then drawing it is not unusual, and (from what I can gather) the concern really is what @LateStarter wrote. But as @PhilB wrote, better not to disturb HMRC if it is not needed. And the penalty is high.

[MisterA]

Thanks all. I only became aware of these rules recently, nobody else has ever mentioned them and I hadn't read about them elsewhere. But, I'm glad that I did find out about them before executing my little scheme.

I made contact with AON (one of my pension providers), and from what I can gather, they'd never heard of the pension lump sum recycling rules either! Their comments didn't instil me with confidence.