Pension recycling loophole is against spirit of law

Pension recycling loophole is against spirit of law

A significant proportion of financial advisers are completely unaware of a rule permitting the recycling of tax-free cash, that could allow them to save their clients tens of thousands of pounds.

According to Ruban Sanmuganathan, a chartered financial planner with Plutus Wealth Management, the method is entirely legal and could save higher rate taxpayers more than £80,000 over 20 years.

He described the technique as a "no brainer", but said many financial advisers were not using it simply because they were unaware the rule existed.

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Mr Sanmuganathan described the technique as follows: after age 55, you crystallise a portion of your defined contribution pension, and take out up to £7,500 as tax-free cash.

You then put it back into your pension and claim the tax relief, which will be between £1,875 and £4,129, depending on your tax bracket.

As long as the amount put back in is less than £7,500, Mr Sanmuganathan said HM Revenue & Customs does not consider it tax-free cash recycling.

Mr Sanmuganathan said a top rate taxpayer who does this every year from age 55 to age 75 would end up receiving an additional £82,580 from the government. 

He added the caveat that a top rate taxpayer would have swapped £7,500 of tax free money for £4,218.73 of tax-free money and £7,031.27 of taxable money.

But he said this still worked out as considerably more. 

"I don't think many advisers are aware of [the rule], and if they are aware of it, they are not doing it as a routine for their clients. Arguably they should be doing it, because there is no catch,"  Mr Sanmuganathan said.

FTAdviser contacted a number of financial planners, and found the majority had not heard of the rule. 

However, when told about it, many were concerned it went against the spirit of the law, and would leave them vulnerable to punitive action by HMRC.

Kim Barrett, an adviser at Barretts Financial Solutions, said he worked on the principle that all tax-free cash recycling was illegal, and this seemed like "blatant tax-free cash recycling".

But while he acknowledged that the rules did technically allow it, he said he would be "very nervous" to use it.

"My fear would be if the Revenue saw too much abuse of it, they would stop it," he said.

Kusal Ariyawansa, a financial planner with Appleton Gerrard, said he would not exploit the loophole on principle, and suggested other advisers also avoid it.

"Advisers need to stop doing these short-term gimmicks," he said.

"Do legitimate tax planning that goes with the spirit of the law. The recycling of tax-free cash is a no-no."

Darren Cooke, a financial planner with Red Circle Financial Planning, said the gain from using the technique would not be worth the effort.

"Unless you are going to do it for a very long time, it isn't worth it," he said.

He also pointed out that it would require savers to crystallise part of their pension, meaning it could no longer be passed on tax free.