There are some situations in which contributions to the pension plan are not authorised. This is frequently presented as an unauthorized payment, and if it is not permitted, serious consequences can result.
A very appealing perk is the opportunity to withdraw 25% of the accrued pension fund tax-free. The temptation to take the 25% tax-free portion that has already received tax relief and reinvest the money to receive another round of tax relief would expose the positive taxation benefits of pensions to misuse. To prevent this from happening, HMRC would treat the entire Pension Commencement Lump sum (PCLS) as an unauthorised payment if several conditions were met.
It is important to emphasise that with Final Salary schemes, you should simply refer to it as your pension commencement lump sum and disregard the 25 percent tax-free terminology because a Final Salary scheme will never provide you with the entire 25 percent of PCLS. If you want the full 25 percent, you must have access to a personal pension, such as a SIPP.
What is Pension Recycling?
Pension recycling is the process of reinvesting tax-free cash and/or income from a pension into a pension system to get additional benefits. There is legislation in place to ensure that the mechanism that gives tax breaks on pension contributions is not manipulated.
For example, in this case,:
A pension member has a million pounds, and after deducting their 25% PCLS, they have £250,000 in their bank account. Then they realise they should contribute another £250,000 to their SIPP or one of their pension schemes in order to receive additional tax relief on the amount of money. This situation is known as the recycling pension.
When Does Pension Recycling Actually Happen?
You will be in breach of the recycling requirements if the recycling was assessed to be pre-planned, which means you made a conscious decision to take the tax-free funds to contribute much more to a registered pension scheme.
When looking for evidence of pre-planning, HMRC will evaluate your purpose for taking the tax-free cash and determine whether you always meant to make the contribution with the tax-free cash payment.
Once it is determined that the recycling was planned, HMRC will consider whether
- the tax-free cash is more than £7,500 including any tax-free cash taken in the previous 12 months
- the total increases in pension payments in the tax year and the two tax years either side is at least 30% of the tax-free cash taken
- the pension amounts paid are significantly larger than might be expected. The usual threshold for defining “much higher” is 30%.
Are There Any Exemptions To The UK Pension Recycling Rules?
HMRC accepts that increases in pension contributions do not violate the recycling requirements in the following cases:
- First, when a person wins or gains a stream of revenue, such as an inheritance or a lottery win, and contributes to a pension as a result.
- Second, they maintain the same contribution rate, for example, 10% of profits, but when profits increase, the contributions climb significantly.
- Third, they enrol in a new employer’s scheme and make the required contribution to the new employer’s pension plan.
Keep in mind that if an unauthorised payment charge is made, the penalty is based on the amount of tax-free cash removed, not the amount recycled back into the pension.
What Are the Implications of Pension Recycling?
Recycling is restricted to these parameters. Even with preparation, tax-free cash can be used to make payments into a pension scheme. However, if all of these restrictions are breached, HMRC will very certainly levy an unauthorised payment charge.
The penalties can vary, but the points covered in the following rules are significant. If a person is caught by the recycling rules, the amount of the tax-free lump sum is considered an unauthorised payment, and any of the following penalties may be imposed:
- A 40% unauthorised member payment charge on the tax-free lump sum paid
- A 15% fee on unauthorised payments of the tax-free lump sum paid
- A scheme sanction fee of 40% of the tax-free lump sum
Keep in mind, however, that all of these costs may be charged for a single unauthorised payment, and this is not automatic.
What Is The Procedure For Paying An Unauthorised Payment Charge?
When an unauthorised payment happens, the scheme administrator should notify the scheme member and report it to HMRC. All unauthorised payments must be reported to the scheme administrator.
Once the scheme administrator has fully informed the pension member of the condition, the pension member must include the breach in their self-assessment. HMRC’s HS345 form particularly explains the information required to fill out the unauthorised payment charges. If you are unfamiliar with the matter, you can read the specific information provided by HMRC in section PTM133800, you can contact HMRC to complete your liabilities, or you can call your pension transfer specialist to acquire a thorough explanation.
Clients should avoid PCLS recycling at all costs, according to our recommendations. The matter, however, is exceedingly tough to understand. So, for example, if your contributions to your scheme are significantly more than anticipated, the HMRC provides guidelines of roughly 30%, but this is not a hard and fast rule.
Another piece of advice is to ask yourself a serious question, such as why take your PCLS if you’re just going to deposit it in your bank? How would you spend the money? Some people reach the age of 55 with their SIPP, take the benefit of 25% PCLS prematurely, and believe that withdrawing the benefit without further planning is a disaster for financial planning.
As a pension wrapper, the fund you have put into the pension plan is exempt from capital gains tax. As a result, if you retain your money invested in your SIPP, for example, your money will grow as long as you keep the scheme. So, you don’t have to run in to cash out your 25% PCLS if you don’t have an emergency.
Unless you have a specific plan for the PCLS, leave it in the pension scheme; you don’t have to take it at 55; you might take it at 56-65, let the money compound, and then take the PCLS amount that you require when you have a project, or you need it.
You do not have to take the entire 25% of your PCLS. Assume you have a million-pound pension plan and need to build a conservatory, which will cost you thirty thousand pounds. Do you need to take two hundred and fifty thousand pounds now to get that thirty thousand pounds? No, as you will then have £220,000 in your bank account.
Another advantage to keeping your money invested in the scheme is that you will get a tax-free inheritance. If the money increases, when you die you can leave it to your beneficiaries tax-free, as long as you do so before the age of 75.
If you live outside the UK, you have one option: you can withdraw the 25% PCLS and invest it in an ISA, which is also exempt from the capital gains tax, but you can only deposit up to £20,000 into an ISA every year at the time of writing.
Cameron James, Expat Financial Planning -Your Trustworthy Pension Transfer Specialist.
Cameron James Expat Financial Planning is the preferred independent financial adviser for Final Salary pension and SIPP transfers. With over ten years of experience transferring pensions, Cameron James is now servicing clients in 26 countries.
We have the qualifications and technical knowledge required to help you transfer to an international SIPP as an expat and a US resident. Our mission is to bring regulated and transparent advice to our clients. As such, our clients know how much their advice will cost in advance, with no hidden fees.
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Transferring a DB or DC pension into a SIPP plan for expats is not a simple decision. Before deciding, many details and procedures must be thoroughly understood. Without this knowledge, the benefit will turn into a potential loss.
It is essential to seek competent advice from a qualified financial adviser to verify that your profile matches the suitable options and to ensure that your choice meets the UK and US regulations. Meet one of our dedicated advisers to get a full understanding of SIPPs.