How to avoid recycling tax-free cash

  • Describe some of the challenges surrounding recycling of pensions tax-free cash
  • Explain HMRC's stance on the issue
  • Identify ways of managing the process
  1. What constitutes a significant increase in contributions?
  2. What constitutes planning?

HMRC covers both of these in its published guidance.

Taking the contribution point first, HMRC uses a 30 per cent rule of thumb – be careful not to confuse this with the ‘30 per cent of PCLS’ condition. This means that HMRC are unlikely to scrutinise additional contributions unless they are 30 per cent more than what the client might otherwise have paid in.

They will also ignore increases that are outside of the client’s control, such as contractual increases, and increases that are due to natural fluctuations, and they will consider the broader context. 

Example 1

Sandra runs her own business, and her income fluctuates. Historically she has contributed 10 per cent of her income each year to a personal pension. 

During the Covid-19 pandemic her income virtually ceased, so she took a PCLS from her personal pension to make up the shortfall.

Sandra changed how her business operated and it bounced back strongly, so this year she has a much higher income than normal. She therefore makes a much higher contribution than normal but it is still at 10 per cent of her income. 

From a recycling perspective, this latest contribution is likely to be disregarded given it was made on the same basis as contributions in previous years and had no relation to any PCLS payment.

When assessing increases, HMRC works on a cumulative basis and will look at contributions over a five-year period. This period includes the tax year in which the client took PCLS, the two tax years before that and the two tax years after. The purpose is to identify cases where individuals are attempting to spread the increased contribution over several years in order to avoid scrutiny.

In terms of the planning aspect, the guidance does not indicate what evidence can or cannot be taken into account. It does say that the onus is not on the individual to prove an absence of planning, it is on HMRC to demonstrate the individual had planned to increase their contributions following receipt of a PCLS.

In terms of other points to note, HMRC is clear in the guidance that recycling can involve more than just the two key transactions of lump sum and contribution. It will look beyond these, and it will take into account other transactions entered into for the purpose of recycling.

Furthermore, there is no prescribed order of transactions and no requirement that the actual PCLS funds are used to make the contribution.

For example, if a member borrowed money in order to make an increased contribution, received a PCLS, and used some or all of the PCLS to pay off the loan, this would put it in the ballpark of recycling.

In terms of how HMRC might identify recycling cases, there are a few points to note. 

Firstly, there is no requirement on scheme administrators to monitor for recycling or report suspected cases. Recycling is a unauthorised payment, so a scheme administrator would have to report it if it took place. However, the administrator’s unlikely to have the full facts, so would be reliant on the member notifying them.

In terms of broader detection measures, HMRC will of course have details of tax relief granted on all personal contributions.

However, they have less data on PCLS payments. Some PCLSs must be included on a scheme administrator’s annual report to HMRC – for example if the client is relying on a form of lifetime allowance protection – but the majority of PCLSs will not be reported.