The Lemon Fool

Hi

My wife and I are planning to retire within this tax year and I could do with some input on possible pension recycling issues please.

My wife's pension will be below the basic tax threshold until State Pension kicks in. Partly on that basis we started her first SIPP in March this year (with £11.2k net/£14k gross) and plan to add a similar amount in March 2023. The rationale being that she can then take £4k out per year - £1k will be tax free and the other £3k will be within her tax threshold, so also tax free.

It now turns out, unexpectedly, that her pension offers a rather generous commutation rate (without impacting survivor pension) so we could get a tax free lump sum of £44.5k. I'm now concerned that could fall foul of recycling rules though.
- the lump sum is obviously well beyond the £7.5k that triggers HMRC interest
- there's barely a usual SIPP contribution as she only just started a SIPP, so a "30% more than usual" test will likely fail
- last year's contribution may already have triggered the >30% of tax free cash anyway

I suspect our best bet is for her to take just £7.4k of the possible tax free cash and avoid inviting HMRC's attention. Am I missing a trick?

Ta
Bob

bucklb wrote:I suspect our best bet is for her to take just £7.4k of the possible tax free cash and avoid inviting HMRC's attention. Am I missing a trick?

Regardless of the source of funds, the SIPP contribution is capped by the available salary. I don't think it would be regarded as recyling if 100% of salary went into the SIPP and the PCLS was used for living expenses in lieu of salary.

Alaric wrote:

bucklb wrote:I suspect our best bet is for her to take just £7.4k of the possible tax free cash and avoid inviting HMRC's attention. Am I missing a trick?

Regardless of the source of funds, the SIPP contribution is capped by the available salary. I don't think it would be regarded as recyling if 100% of salary went into the SIPP and the PCLS was used for living expenses in lieu of salary.

Sorry Alaric , but that is precisely what the recycling rules are designed to prevent - you boosting your pension contribution by a large amount because you can live off the PCLS.

ursaminortaur wrote:

Alaric wrote:
Regardless of the source of funds, the SIPP contribution is capped by the available salary. I don't think it would be regarded as recyling if 100% of salary went into the SIPP and the PCLS was used for living expenses in lieu of salary.

Sorry Alaric , but that is precisely what the recycling rules are designed to prevent - you boosting your pension contribution by a large amount because you can live off the PCLS.

Isn't the Money Purchase Annual Allowance relevant here?

I found this helpful - https://techzone.abrdn.com/public/pensi ... -free-cash

Including this snippet
"Assuming the recycling was pre-planned, an unauthorised payment charge will apply to the tax free cash taken if all of the following limits are exceeded.

The tax free cash (including any tax-free cash taken in the past 12 months) is more than £7,500 and
The total of the 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, and
The pension payments made are significantly larger (generally 30%) than might be expected."

Also
"It's also worth noting that tax free cash can be used to fund someone else's pension without falling foul of the tax free cash recycling rules - for example, making payments to a pension for a spouse/partner, child or grandchild. The rules only apply when the individual is recycling tax free cash back into a pension in their own name."

kempiejon wrote:

ursaminortaur wrote:
Sorry Alaric , but that is precisely what the recycling rules are designed to prevent - you boosting your pension contribution by a large amount because you can live off the PCLS.

Isn't the Money Purchase Annual Allowance relevant here?

It will be relevant once potentially taxable income is taken.

The OP is proposing to

take £4k out per year - £1k will be tax free and the other £3k will be within her tax threshold, so also tax free.

Once the £3k taxable income is taken (even though no tax will actually be payable on it since it will be covered by the personal allowance) the MPAA will be triggered and the maximum contribution to any DC pension after that will be the MPAA limit (currently £10,000 gross). So it will no longer be possible to make the full £11.2k net/£14k gross contributions currently being made.

ursaminortaur wrote:

kempiejon wrote:
Isn't the Money Purchase Annual Allowance relevant here?

It will be relevant once potentially taxable income is taken.

The OP is proposing to

take £4k out per year - £1k will be tax free and the other £3k will be within her tax threshold, so also tax free.

Once the £3k taxable income is taken (even though no tax will actually be payable on it since it will be covered by the personal allowance) the MPAA will be triggered and the maximum contribution to any DC pension after that will be the MPAA limit (currently £10,000 gross). So it will no longer be possible to make the full £11.2k net/£14k gross contributions currently being made.

Just to add - you should make any contribution which might exceed the MPAA limit in the tax year you start withdrawing potentially taxable income before you withdraw it and trigger the MPAA.

https://www.curtisbanks.co.uk/case-study/money-purchase-annual-allowance-mpaa-fact-sheet/

The MPAA will apply from the day after your trigger event. Any contributions to money purchase schemes made during the tax year but before your trigger event will just be tested against the annual allowance as normal.

The MPAA will apply from the day after your trigger event. Any contributions to money purchase schemes made during the tax year but before your trigger event will just be tested against the annual allowance as normal.

That's handy tip. I must try and to remember it if it's relevant to my last year of full time employment.

Thanks for people's input. It sounds like I'm right to be thinking a little caution is required.

On the whole I'm still planning for my wife to take a low enough amount of tax free cash to stay under the tax man's radar.

Just thought - does it make any odds that the tax free cash is from a defined benefit scheme?

I gather starting a defined benefit scheme does not have the same impact on paying in to a SIPP as taxing taxable income from a defined contribution scheme. Hoping (but not expecting) that tax free cash from a defined benefit scheme might not fall within the same recycling rules as defined contributions

bucklb wrote:Just thought - does it make any odds that the tax free cash is from a defined benefit scheme?

I gather starting a defined benefit scheme does not have the same impact on paying in to a SIPP as taxing taxable income from a defined contribution scheme. Hoping (but not expecting) that tax free cash from a defined benefit scheme might not fall within the same recycling rules as defined contributions

No, the fact that the PCLS is from a DB scheme makes no difference as far as the recycling rules are concerned. The MPAA though is only triggered by taking potentially taxable drawdown income from a DC scheme and the lower MPAA limit only applies to contributions to DC schemes.

Gettting a little more esoteric/specific here but ...

If my wife could get £44.5k tax free cash from her pension and we'd already added £11.2k cash to her SIPP (made up to £14k cash after tax relief) would that count as exceeding 30% of the tax free cash?

30% of the TFC is £13.35k so £11.2k nett is well within that threshold, but £14k gross not so much