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HMRC internal manual

Pensions Tax Manual

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HM Revenue & Customs
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Unauthorised payments: Deemed or specific situations that are unauthorised payments: recycling of pension commencement lump sums: examples to illustrate when the recycling rule does not apply

Glossary PTM000001
   

Please note that the examples are just that - examples. The list is not and cannot be comprehensive. At the end of the day, each case will have to be decided on its own facts and merits to establish whether or not all of the requirements set out in the bullet points at PTM133810 have been met. It is only where they have all been met that recycling will have occurred.

Example 1 - Change of employee contribution level on moving to new employer

After 20 years, an individual leaves Employer A and takes a pension commencement lump sum from Employer A’s registered pension scheme. During the membership of that pension scheme as an employee, the individual was not required to make any contributions and nor did the individual ever make any voluntary contributions to his employer’s scheme or any other private pension contributions to another registered pension scheme. Apart from the benefits from Employer A, the individual has no other pension saving.

Before leaving Employer A, the individual applied for and got another job with Employer B, who has a registered pension scheme to which that individual would have to pay contributions as a condition of membership. On leaving Employer A, the individual takes up the job with Employer B and joins Employer B’s pension scheme, as intended.

As the individual is simply paying contributions out of that individual’s salary from Employer B in the ordinary course of the membership of Employer B’s pension scheme, the contributions are not significantly greater than might have been expected.

Example 2 - Consistent basis of contributions with fluctuating salary levels

A member’s annual contributions to registered pension schemes have fluctuated in the 5 years (years 1 to 5) leading up to the year in which the member takes a pension commencement lump sum (year 6). The contributions in year 6 are £15,000, which is an increase of more than 30% on the previous year’s contributions of £10,000 (£10,000 + 30% = £13,000).

However, although the member’s contributions in years 1 to 5 have fluctuated, the basis on which they were calculated has not changed. The contributions were based on a set percentage of the member’s salary, which has, itself, fluctuated because that salary includes bonus payments on the following basis:

Year 1 - bonus paid

Year 2 - bonus paid

Year 3 - no bonus paid

Year 4 - bonus paid

Year 5 - no bonus paid

Year 6 - bonus paid.

Although the member’s contributions have increased by more than 30% between year 5 and year 6, the amount of increase - £5,000 - does not represent a significant increase. This is because the contributions for year 6 are paid on the same basis as the contributions paid in years 1 to 5 so the amount of the contributions is not more than 30% more than the contributions that might otherwise have been expected.

Other circumstances where contributions might fluctuate but are still paid on a set basis are where a member pays contributions each year equal to the amount of the member’s UK earnings that would ordinarily be over the threshold for higher rate tax or where contributions are based on a percentage of self-employed profits.

Similarly, a pay increase on promotion may be the reason why a contribution amount is increased, but may still be made on a consistent (percentage) basis.

Example 3 - Use of Retail Price Index adjustments

An individual takes a pension commencement lump sum and then pays contributions into a registered pension scheme. The contributions - £7,000 - are the first such contributions by, or in respect of, the individual for the last 5 years.

The last contribution that was paid into a registered pension scheme in respect of the individual was paid 6 years ago and amounted to £5,000. Allowing for an adjustment to take into account the increase in the Retail Prices Index (RPI) since that contribution was paid the equivalent value of that contribution at the time that the lump sum is paid is £6,000.

The amount of contributions paid after the lump sum was taken - £7,000 - represents an increase of more than 30% on the contributions that were last paid in respect of the individual (£5,000 + 30% = £6,500). However, there has not been a significant increase in contributions. This is because when the increased contributions (£7,000) are measured against the last contributions, as adjusted to allow for RPI increases, the amount of the increase is now less than 30% (£6,000 + 30% = £7,800).

(As the previous contribution was 5 years earlier, RPI is used to produce a “current value” for comparison purposes. The use of RPI to produce a “current value” will only be necessary where there is no pattern of contributions.)

Example 4 - Illustration of the cumulative basis

In the tax year (year 1) in which a pension commencement lump sum of £35,000 is received by a scheme member, who intended to use that lump sum to increase contributions to a registered pension scheme, the contributions to registered pension schemes relating to that member increase from the previous 10 years’ annual contributions of £10,000 to £10,500 - as it is an increase of 5%, the amount by which the contributions have increased in that year is not a significant increase.

In the following tax year (year 2) the contributions increase to £11,000 - an increase of 10% on the usual contributions of £10,000 for that year (the amount of annual contribution that would have been expected before the payment of the lump sum). This is not a significant increase as the £1,000 increase, in itself, is less than 30% of the usual annual contributions and the £1,000 increase and the increase in year 1, together, do not exceed the 30% limit (year 1 increase of £500 plus this year’s increase of £1,000 = 15% of the amount of usual annual contributions of £10,000 for year 2).

In the next following tax year (year 3), contributions increase to £12,000 - an increase of 20% on the usual contributions of £10,000 for that year (the amount of annual contribution that would been expected before the payment of the lump sum). This is now a significant increase in contributions as, cumulatively, the amount of the increase - £3,500 - is more than 30% of the amount of contributions that might be expected in that year (year 1 increase of £500 + year 2 of £1,000 + this year’s of £2,000 = 35% of the usual annual contributions of £10,000).

However, the recycling rule is not triggered as the significant increase in the member’s contributions - £3,500 - does not exceed 30% of the amount of the pension commencement lump sum (lump sum of £35,000 x 30% = £10,500).

RPI is not required because the “current value” of contributions was £10,000.

Example 5 - Contributions based on profits from a self-employment

An individual receives a pension commencement lump sum as part of retiring from an employment. The individual then concentrates on a self-employment and decides to use 10% of each year’s profits to fund contributions into a new registered pension scheme. Therefore, some months after receiving the pension commencement lump sum the individual pays the first contribution into this new registered pension scheme. That contribution will not be regarded as caught by the recycling rule as the contribution is made because of the self-employment and is not part of a device to recycle the lump sum. The member did not pre-plan to use the pension commencement lump sum as a means to pay significantly greater contributions into the registered pension scheme.

Example 6 - Windfall

A member sets in motion the payment of a pension commencement lump sum from a money purchase arrangement.

Whilst waiting for quotes on the value of the units that comprise the member’s money purchase arrangement, the member has a substantial lottery win. (This might apply equally to an inheritance or financial settlement.)

Following receipt of the unit valuations in the meantime, the pension commencement lump sum can be paid. The member decides to take the lump sum in order to clear some existing debts, as planned. When the lottery winnings are received, the member pays a substantial contribution into a registered pension scheme, of an amount equal or less than the lottery winnings. That contribution will not be regarded as caught by the recycling rule because the member did not pre-plan to use the pension commencement lump sum as a means to pay significantly greater contributions into the registered pension scheme. The contribution is made because of the lottery win and not because of the lump sum.