Case study: how to avoid being caught by the pension recycling rules

Debbie is aged 58 and works for an engineering company. She has built up two pensions; her workplace pension as well as a SIPP. Her daughter wants to get on the housing ladder and has recently found the perfect house. Debbie wants to discuss how she can access her SIPP to use a pension commencement lump sum (PCLS) of £20,000 to help fund her daughter’s deposit.

Debbie has steadily paid into her pensions over the last 20 years. In the past three years her contributions have been £15,000 a year. She is approaching retirement and has recently made efforts to increase her pension funding. This led her at the start of the tax year to pay an extra £10,000 into her SIPP after receiving a bonus from her employer.

Debbie’s financial adviser is worried her plans to access her PCLS may raise implications with the PCLS recycling rules. These aim to combat the potential issue of people ‘double dipping’ on tax relief by taking their tax-free cash and then immediately ploughing it back into their pension to gain more tax relief.

There are several conditions that must be satisfied for a PCLS to be considered as ‘recycled’. Broadly:

• the PCLS (and any other PCLSs received in a 12-month period) must be more than £7,500;
• the cumulative amount of additional contributions is over 30% of the amount of the PCLS; and
• the contributions for the member are significantly above what they would normally be.

Debbie’s financial adviser initially judged the recycling rules would be broken. Debbie’s contributions had certainly recently increased significantly – from £15,000 to £25,000 – and the increase of £10,000 is much higher than the 30% threshold, which would be £6,000 on a £20,000 PCLS. And her PCLS would be more than £7,500.

The fact Debbie increased her contributions a few months before accessing the PCLS wouldn't affect the judgment. The Pensions Tax Manual (PTM) has further guidance on when HMRC may apply the test. The increase is tested on a cumulative basis over five years; two years before the PCLS is taken, the tax year the PCLS was made and the two years following the payment.

But there are a few factors in Debbie’s favour.

First, as Debbie’s contributions have been steady at £10,000 over the past few years, it could be this sudden spike might set off warning bells. However, she has been following a consistent trend of pension saving, whereas this condition is likely to catch those who contribute minimal amounts, take a PCLS and markedly increase their subscriptions afterwards.

HMRC is also looking for evidence that the increase in contributions is a direct result of the PCLS. However, Debbie has allocated a specific use for her PCLS, to fund her daughter’s house deposit. Furthermore, Debbie will continue in employment, paying tax at the higher rate and funding her pension scheme from her earnings.

But there is also a final condition that has to be satisfied before a PCLS can be said to be recycled. And that is whether the recycling was planned – in other words was it a conscious decision?

In Debbie’s case this is a hard no. She has a specific use for the PCLS. In addition, if she continues to pay bonuses into her SIPP each tax year then this will weaken the case against her.

As the barrier between accumulation and decumulation blurs even further, it’s likely there are going to be many more of these cases where it could be argued that recycling has taken place, as people take tax-free cash at the same time as contributing to their pension. In such cases, clients need to work with their advisers need to make sure they have good written evidence of the decisions they took and why.