RPSM04104980 - Technical Pages: Taxation: Unauthorised Payments: Recycling of pension commencement lump sums: Examples

Examples to illustrate when the recycling rule applies

Please note that the examples that follow are just that - examples. This list is not and cannot be comprehensive. At the end of the day, each case will have to be decided on its own facts and merits to establish whether or not all of the requirements set out in the 6 bullet points at RPSM04104920 have been met. It is only where they have all been met that recycling will have occurred.

Example 1 - Aggregation of pension commencement lump sums paid at different times

An individual takes a pension commencement lump sum of £9,000 on 1st May 2006 with the intention of using it to pay significantly greater contributions to a registered pension scheme. This is the first time the individual has taken such a lump sum. The amount of the lump sum does not exceed 1% of the standard lifetime allowance (for the 2006/07 tax year this amount is £15,000 - 1% of £1,500,000) and no other such lump sums were paid to the individual in the last 12 months. The recycling rule is not triggered because the amount of the pension commencement lump sum is less than 1% of the standard lifetime allowance (for the 2006/07 tax year this amount is £15,000 - 1% of £1,500,000).

On 1st November 2006 the same individual takes another pension commencement lump sum of £7,000 in order to further significantly increase contributions to a registered pension scheme. The total significantly increased contributions amount to £7,000. Because the individual has received another pension commencement lump sum within the previous 12 months (the lump sum of £9,000 taken on 1st May 2006), the amount of the later lump sum of £7,000 must be aggregated with the amount of that previous lump sum. The aggregate amount exceeds 1% of the standard lifetime allowance (for the 2006/07 tax year this amount is £15,000 - 1% of £1,500,000) (£9,000 + £7,000 = £16,000). The recycling rule is triggered because:

• the individual specifically took the pension commencement lump sum of £7,000 in order to pay £7,000 back into a registered pension scheme as a tax relievable contribution,
• that lump sum of £7,000 (together with the earlier lump sum of £9,000) exceeds 1% of the standard lifetime allowance (for the 2006/07 tax year this amount is £15,000 - 1% of £1,500,000), and
• the amount of the significantly increased contribution (£7,000) exceeds 30% of the pension commencement lump sum of £7,000 (£7,000 x 30% = £2,100).

The recycling rule applies to the second lump sum, resulting in a deemed unauthorised payment of £7,000.

Example 2 - Other money available when pension commencement lump sum used to fund increase in contributions

An individual intends to use a pension commencement lump sum of £35,000 that he is able to take from a registered pension scheme to fund a significantly greater contribution of £40,000 to another registered pension scheme in the run-up to the end of the 2006/07 tax year. The individual has more than £40,000 available savings and so could make that contribution using those savings, but to do so would mean using up most of those savings, and so instead takes the £35,000 pension commencement lump sum and uses that. The fact that the individual had other available money that could have funded the significantly greater contribution does not mean the recycling rule is avoided.

The recycling rule would also apply if, instead of funding the contribution directly from the lump sum, the individual takes the money that pays the contribution out of the available savings, and then, uses the £35,000 pension commencement lump sum to replenish those savings.

Despite paying the increased contributions from existing savings, the recycling rule is triggered because the individual always intended the pension commencement lump sum to be an integral aspect of providing the means, albeit in an indirect way, to pay those increased contributions.

In both situations in Example 2, the significantly greater contribution is made “because of” the pension commencement lump sum, and this was planned by the individual from the outset.

But, as RPSM04104925 says, it is not enough to establish that recycling has occurred for the pension commencement lump sum to be paid into the same bank account as that from which the savings were taken to pay the increased contributions. This does not of itself mean that the contributions have been made “because of” the lump sum. HMRC has to show that the individual intended to use the lump sum as the indirect means of making those increased contributions.

Example 3 - Illustration of a significant increase in contributions

A member’s annual contributions to registered pension schemes have been £20,000 a year for the last 10 years. In the year in which a pension commencement lump sum is received, the contributions are £30,000. The member took the lump sum with the prior intention of using it to make significantly greater contributions to a registered pension scheme.

Based on the previous 10 years, the amount of contributions that might have been expected is £20,000. So there is a significant increase in contributions as the increase of £10,000 is more than 30% of the amount that would have been expected in that year (the limit is reached where the amount of the increase in contributions - £10,000 - exceeds £20,000 x 30% = £6,000).

Example 4 - Illustrating connection with scheme sanction charge

In the tax year (2006/07) in which a pension commencement lump sum of £35,000 is received by a scheme member (who intended to use that lump sum to increase contributions to a registered pension scheme), the contributions to registered pension schemes relating to that member increase from the previous 10 years’ annual contributions of £10,000 to £25,000. The amount of the increase, £15,000, is a significant increase in contributions as the usual annual contributions being paid before the payment of the pension commencement lump sum have increased by more than 30% (£10,000 x 30% = £3,000). The recycling rule is triggered because:

• the member intended to use the pension commencement lump sum to pay significantly greater contributions to a registered pension scheme,
• the lump sum of £35,000 exceeded 1% of the standard lifetime allowance (for the 2006/07 tax year this amount is £15,000 - 1% of £1,500,000),
• significantly greater contributions were paid, and
• the cumulative amount of the additional contributions (£15,000) exceeds 30% of the lump sum (£35,000 x 30% = £10,500).

There is a deemed unauthorised payment, based on the amount of the pension commencement lump sum of £35,000.

The member’s lifetime allowance was available on all of the pension commencement lump sum and it was paid from a money purchase arrangement which had a value of £140,000 when the lump sum was paid. As the unauthorised payment, which is equal to the entire amount of the lump sum, represented 25% of the value of the member’s fund, the unauthorised payments surcharge applies in addition to the unauthorised payments charge. The member is liable to an income tax charge of £19,250, based on the amount of the unauthorised payment of £35,000 (the rate for the charge is 55%, which is made up of a rate of 40% for the unauthorised payments charge and a rate of 15% for the surcharge).

The scheme administrator of the scheme from which the lump sum is paid is liable to a scheme sanction charge. The initial liability is £14,000 (a rate of 40% based on the amount of the lump sum) but the amount could reduce to £5,250, depending on how much of the unauthorised payments charge liability is met by the scheme member. The scheme administrator is able to apply to HMRC to ask it to discharge the liability in respect of the scheme sanction charge where the scheme administrator considers that the grounds for such a discharge are just and reasonable.

Example 5 - Paying the pension commencement lump sum as a contribution

A 55 year old member of a registered pension scheme has built up a pot of £100,000 in a money purchase arrangement. The member has earnings of £75,000. The member is making contributions amounting to 10% of those earnings to another registered pension scheme in respect of a pensionable employment. The only other asset of note that the member has is the member’s family home, which is mortgaged. The member draws a pension commencement lump sum of £25,000 from his £100,000 pot, which is fully covered by lifetime allowance.

The member pays an immediate contribution of £25,000 into a registered pension scheme. The member is able to claim higher rate relief in respect of all of the contributions of £32,500 that the member makes in the tax year. Where the member had the intention at the time of taking the pension commencement lump sum of using that lump sum to make additional contributions, those contributions would be regarded as triggering the recycling rule. There would be an unauthorised payment of £25,000.

Example 6 - Borrowing to facilitate recycling

An individual, who has not been in pensionable service nor made any private pension provision for the last 5 years decides to draw on a deferred benefit from a previous employment with the intention of using the expected pension commencement lump sum of £20,000 to fund a contribution to a registered pension scheme run by the individual’s current employer. Rather than wait for the lump sum, the individual takes out short-term borrowing of £15,000 in order to make an immediate contribution of the same amount, in time to meet the looming end of the current tax year.

The individual then receives the pension commencement lump sum, which enables the individual to repay the borrowing.

There would be an unauthorised payment of £20,000.

Example 7 - Employer contributions facilitating recycling

A 58 year old member of a registered pension scheme is the controlling director of a close company. The company makes annual pension contributions of £10,000 in respect of the member to the company’s pension scheme. The member has built up £1m in a separate money purchase arrangement. The member crystallises half of the value of the arrangement, taking a pension commencement lump sum of £125,000, and putting the balance into an unsecured pension arrangement.

The member then loans £125,000 to the company, which then makes a contribution of £125,000 to another registered pension scheme on behalf of the member (in addition to the usual £10,000 it pays to the company scheme).

Where it is established that it was “because of” the lump sum that the loan and, hence the additional contributions, would be made, the lump sum will be regarded as caught by the recycling rule.

Example 8 - salary sacrifice type arrangements

An employee intends to receive a pension commencement lump sum of £100,000 with the intention of using it to pay a contribution of the same amount into a registered pension scheme. However, rather than taking the lump sum and then using it to make the contribution, the employee instead arranges a salary sacrifice in respect of a bonus of £100,000 that would otherwise have been paid to the employee. As part of that salary sacrifice arrangement, the employer pays a contribution of £100,000 into a registered pension scheme in respect of the employee. That contribution of £100,000 is a significant increase.

The recycling rule is triggered because:

• the employee intended to use the pension commencement lump sum as a means to pay a contribution to a registered pension scheme, and
• that objective has been achieved through the salary sacrifice arrangement - taking the lump sum instead of the bonus foregone has allowed the individual to place the same £100,000 into a pension scheme that would have been paid had the employee taken the lump sum and then used it to pay a contribution of the same amount into the scheme, and
• there has been a significant increase in contributions and that increase represents more than 30% of the amount of the lump sum.