However, pensions are one area where recycling is not always such a great idea, specifically when it comes to pension commencement lump sums (PCLS, or tax-free cash).
So, what is PCLS recycling?
Before I get into the rules, it is worth covering what PCLS recycling actually is, and why anyone would want to do it.
Essentially it involves using PCLS payments to make additional pension contributions, in order to gain what HM Revenue & Customs terms "artificially high" amounts of tax relief. In order to prevent this, all or part of a recycled PCLS may be deemed an unauthorised payment, carrying the associated tax penalties.
When does PCLS recycling occur?
It is an understatement to say that the PCLS recycling rules are tricky. Some of the actions that might indicate recycling could also occur as part of normal pension planning: the rules try to take this into account, and as a result are rather complex.
There are several conditions that all need to be met in order for the rules to apply, and even HMRC’s guidance acknowledges that not many PCLS payments would be caught. However, it is still an important thing to watch out for, as the penalties can be harsh if a person does meet all of the conditions.
1. A person receives a PCLS payment, and as a result, there is a "significant increase" in their contributions.
If you think this condition sounds a little vague and difficult to prove, you are not alone.
Unfortunately it does not get much clearer as you try to define it. HMRC’s guidance says that as a general rule of thumb, there will not be a significant increase unless the additional contributions are worth more than 30 per cent of the contributions that might otherwise have been expected.
How someone might determine the contributions that ‘might otherwise have been expected’ is another challenge altogether. It could, for example, involve looking at the person’s contribution history and other factors influencing their contributions.
It is worth noting that third-party and employer contributions would also be considered here. HMRC also acknowledges that it is possible for there to be a significant increase that was not a result of the PCLS payment, in which case, the condition would not be met.
2. The recycling was planned in advance.
This could prove a key condition in many cases: the individual must have made a conscious decision to withdraw a PCLS in order to make larger contributions. If someone only decided to make larger contributions later, having already taken a PCLS, this would not be caught by the rules. In the event of a dispute, the onus is on HMRC to prove that pre-planning took place.
3. The amount of PCLS taken is more than £7,500.
There are a couple of notes to add here. Firstly, the £7,500 figure only applies for events taking place since April 6 2015. Before then, it was 1 per cent of the standard lifetime allowance at the time. It is also worth noting that this condition looks at all PCLS taken in the previous 12 months.
4. The cumulative amount of the additional contributions is more than 30 per cent of the PCLS.
Along with the requirement for the additional contributions to be worth more than 30 per cent of the contributions that could otherwise have been expected, the additional contributions also need to be worth more than 30 per cent of the PCLS.
Where the rules refer to the ‘cumulative amount’, this is a measure to help ensure people cannot avoid the recycling rules simply by spreading their additional contributions over a period of time. The time period looked at is the tax year in question, the two preceding tax years, and the two following tax years.
While PCLS recycling is not a frequent occurrence, the high unauthorised payment charges make it well worth watching out for any planning that might be caught by the rules.
There are many great ways to recycle, but this is definitely one to avoid.
Jessica List is pension technical manager at Curtis Banks
