RPSM09208020 - Member Pages: Member benefits: Unauthorised member payments: What is the recycling rule and how does it operate?

What is the recycling rule and how does it operate?

What is recycling?

Recycling of a pension commencement lump sum using that lump sum as the means to significantly increase contributions to a registered pension scheme. The recycling rule is intended to prevent the systematic exploitation of the tax rules for registered pension schemes to generate artificially high amounts of tax relief by using the pension commencement lump sum to make a further, tax relieved, contribution into a registered pension scheme. The most straightforward example of recycling is that of a member arranging to receive a pension commencement lump sum with the intention of investing it as a tax relieved contribution into the same or another registered pension scheme. There are other examples further down this page and in RPSM04104980.

When the recycling rule applies then all or part of the pension commencement lump sum is treated as an unauthorised member paymentfor tax purposes. Recipients of unauthorised member payments are liable for special stand alone tax charges of either 40% or 55% of the payment depending on whether the amount of the lump sum in question that is deemed to be an unauthorised payment exceeds a set surcharge threshold of 25%. See RPSM04104640 for more details of the surcharge threshold. In addition the scheme may face a scheme sanction tax charge of at least 15% which its rules may allow it to recover from the member. So some or all of a lump sum that would otherwise have been paid as a tax-free pension commencement lump sum will instead become subject to tax charges totalling as much as 70% of the amount of the unauthorised payment. For more detail on the unauthorised payments tax charges see RPSM04104000 onwards.

When does the recycling rule apply?

The recycling rule applies in respect of all pension commencement lump sums paid on or after 6 April 2006 where those lump sums are used as part of a recycling device regardless of when the significantly increased contributions are actually paid. Such significantly increased contributions can include contributions paid in the 2004/05 and 2005/06 tax years. For the rule to apply it is important to note that all of the following 6 conditions have to be met.

1. An individual receives a pension commencement lump sum.
2. Because of the lump sum, the amount of contributions paid into a in respect of the individual is significantly greater than it otherwise would be. A significant increase is one of at least 30%. The increase must be because of the lump sum. So if contributions are significantly increased for some other reason this will not constitute recycling. For further guidance about what is a significant increase in contributions see RPSM04104940.
3. The additional contributions are made by the individual or by someone else, such as their employer.
4. The recycling was pre-planned, broadly the individual took the decision to recycle before the pension commencement lump sum was paid (even if significantly increased contributions are not paid until after). The onus is on HMRC to show that pre-planning took place rather than on the individual to prove the contrary. So, in the event of a dispute between a HMRC officer and an individual about whether any recycling was pre-planned, the onus is not on the individual to prove the absence of intention. However, the HMRC officer will be entitled to take into account any evidence that points towards pre-planning - for example the fact that an individual has invested in a product specifically designed to facilitate recycling and marketed or advertised as such. For further guidance about determining whether the recycling was pre-planned see RPSM04104930.
5. The amount of the pension commencement lump sum, taken together with any other such lump sums taken in the previous 12 month period, exceeds 1% of the standard lifetime allowance 
6. The cumulative amount of the additional contributions exceeds 30% of the pension commencement lump sum. For further guidance about the cumulative basis of the recycling rule see RPSM04104950.

As all the above conditions have to be met before there can be recycling, very few lump sum payments will be affected by this recycling rule. Pension commencement lump sum payments are not caught if they are paid as part of an individual’s normal retirement planning.

Scope of the recycling rule

The scope of the recycling rule includes any transaction entered into for the purposes of recycling. The recycling rule will apply where an individual envisages recycling a by any means; from simply reinvesting the lump sum back into a by way of a paid by the individual, through to the use of any devices, schemes, arrangements and understandings of any kind, whether or not legally enforceable, that enable the effective recycling of a pension commencement lump sum.

If a pension commencement lump sum is taken as part of a structured and pre-planned arrangement for paying significantly greater contributions to a registered pension scheme, the fact that the individual has other funds from which the significantly greater contributions are paid or could have been paid does not mean that the recycling rule is avoided.

Examples of when the recycling rule applies

Examples that illustrate situations where the recycling rule applies are given in RPSM04104980 and include the following:

• using the pension commencement lump sum itself to make a contribution
• borrowing to facilitate recycling i.e. taking out a loan to provide the wherewithal to pay a contribution into a registered pension scheme with a pension commencement lump sum to be used to repay the that loan
• manufacturing salary sacrifice type arrangements as the means of making a contribution with the pension commencement lump sum replacing the sacrificed salary
• otherwise manufacturing employer contributions to facilitate recycling.

Circumstances where the recycling rule does not apply

The recycling rule is not intended to apply to individuals who simply increase contributions to registered pension schemes (or who have increased contributions paid in respect of them, such as by salary or redundancy sacrifice) with the intention of increasing the benefits that will ultimately be paid from those schemes, particularly a pension commencement lump sum. This is provided no pension commencement lump sum is actually used as the means to increase those contributions, whether in a direct or indirect way. This is because the recycling rule applies only where contributions are significantly increased “because of” the lump sum.

For example, an individual might pay significantly greater contributions as part of normal retirement planning and simply fund those contributions from the sale of investments, deductions from salary, salary sacrifice, redundancy sacrifice or from existing savings. A pension commencement lump sum may be an integral aspect of the increased contributions if obtaining a larger lump sum is a reason for making those contributions. But the recycling rule does not apply in these circumstances unless the individual intended to use the pension commencement lump sum as the means to make those increased contributions, whether in a direct or indirect way.

The mere fact that a pension commencement lump sum is paid into the same bank account as that from which savings or the proceeds of sale of investments were taken to pay the increased contributions does not in itself mean that the contributions have been paid “because of” the lump sum. The individual must still be shown to have intended to use the lump sum as the indirect means of making the increased contributions.

Also the recycling rule does not apply where an individual takes a pension commencement lump sum and, at the time of taking that lump sum, had no intention of using the lump sum as a means, whether directly or indirectly, to pay contributions into a registered pension scheme. This is so even if the individual subsequently decides to use the lump sum received to make significantly increased contributions to a registered pension scheme. This is because the recycling rule applies only where the recycling was planned before the first relevant transaction - see RPSM04104930.

Examples of when the recycling rule does not apply

Examples that illustrate situations where the recycling rule does not apply are given in RPSM04104990 and include the following:

• where the level of employee contribution payable increases following a change of employment
• where the basis on which contributions are paid is consistent (e.g. 5% of salary) but salary levels fluctuate
• where contributions do not increase substantially after adjusting for RPI increases to contributions last made some years ago
• where there is an increase in employer contributions for a reason unconnected with a pension commencement lump sum
• where an inheritance, a genuine windfall or a financial settlement is used to make significantly increased contributions
• where contributions are based on fluctuating profits from a self-employment.

Who do I need to tell about recycling?

If you recycle a pension commencement lump sum you are required to notify your scheme administrator. For more details see RPSM12200035.