Recycling Rules
30 August 2006 (updated December 2006) / Members
IMPORTANT CHANGE IN TAX LEGISLATION APPLYING TO THE USE OF A RETIREMENT LUMP SUM TO INCREASE PENSION BENEFITS
Please read this note and the Revenue’s Guidance Note carefully. This rule will affect you if you are planning to increase contributions to a pension scheme using all or part of a retirement lump sum you have received or are about to receive.
New rules now apply to pension scheme members, where a retirement lump sum is used in a pre-planned way to fund extra pension contributions, giving rise to a 40% tax charge on the entire lump sum.
Guidance and examples of what does and does not count as recycling can be found on Registered Pension Scheme manual from RPSM04104900 onwards which can be found on the HMRC web site at:
www.hmrc.gov.uk/MANUALS/RPSMMANUAL/RPSM04104900.htm
HMRC has stated that this will also apply to lump sum payments used to buy Additional Pension from 1 January 2007. If a member takes a lump sum from the Teachers’ AVC Scheme and reinvests this into a pension scheme, this could likewise be a breach of the recycling rule. Prudential will need to be contacted accordingly. This recycling rule may also affect those who are contemplating an increase in contributions prior to retirement (including Teachers’ Additional Voluntary Contributions (TAVCs) with Prudential) in the expectation of indirectly funding the increase from the retirement lump sum. Hence, an increase in contributions to buy Additional Pension or TAVCs with Prudential could also be affected if the member intended to fund the increase indirectly from the lump sum.
Please note it is a member’s responsibility to advise us whether the recycling rules have been breached within 30 days of the breach occurring. Members would then inform HMRC in one of two possible ways:
- Members who receive a self-assessment return should enter the unauthorised payment on their tax return by the 31 January following the end of the tax year in which the recycling is triggered. The deadline is 30 September following the end of the tax year if the member wishes HMRC to calculate the tax due;
- Members who do not normally receive a self-assessment return must notify HMRC of the unauthorised payment by 30 September following the end of the tax year in question.
Please note that HMRC have the power to look into individual cases to see if the recycling rules have been breached. If after reading the HMRC Guidance Note and our summary below, you are still unsure whether the recycling rules affect you personally, you should speak to an independent financial advisor or contact HMRC at the address below:
HM Revenue & Customs
Audit & Pension Schemes Services
Yorke House
Castle Meadow Road
Nottingham
NG2 1BG
Telephone number (0115) 974 1600
What is recycling?
The government has been concerned about people who use their tax free lump sum to re-invest in the same or other pension arrangements. The use of a tax free lump sum in this way is known as “recycling”. The Finance Act 2006 received royal assent on 19 July 2006 and affects those who directly or indirectly reinvest lump sums into a pension scheme. Members who breach the recycling rules will be liable to a potential “unauthorised payments charge” of 40%. When the amount of the unauthorised payment is equal to or exceeds 25% of the value of the member’s rights in the scheme, this could also trigger an unauthorised payments surcharge of 15%.
Who will be caught by the new recycling rules?
The government has no desire to affect an individual’s “normal retirement planning”, but is concerned about individuals who pre-plan the use of the lump sum to increase their pension benefits. Such pre-planned measures which would be caught by the recycling rule include:
- Any member who makes a significant increase in contributions to a pension scheme in the two tax years leading up to retirement and the tax year of retirement itself.
- members who plan to use their retirement lump sum from the Teachers’ Pension Scheme or any other pension scheme with the intention (prior to its receipt) of investing the lump sum into another pension scheme; or
- the use of savings or a loan to fund additional pension benefits prior to retirement, with the intention of using the lump sum to replenish available savings or repay the loan when the retirement lump sum is received. (Please see 3.9.2 of the draft HMRC Guidance Note).
Please note this will also apply if the member is planning higher payments to Teachers’ Additional Voluntary Contributions (TAVCs) with Prudential or looking to fund payments to another pension scheme. The recycling rule will also affect a member if they pre plan to take a lump sum and then reinvest this into another registered pension scheme. Thus, if the member takes a tax free lump sum from the Teachers’ Pension Scheme (TPS) and pays this into another pension scheme (such as a personal or stakeholder pension scheme), they may have breached the rules on recycling, subject to the conditions stated below and in the HMRC Guidance Note (e.g. For the recycling to apply, the retirement lump sum must be greater than 1% of the Lifetime Allowance or the contribution must be more than 30% of the basic lump sum).
HMRC will take into account the pattern of contributions made over the years prior to the member’s retirement. The draft Guidance Note refers to the two tax years either side of retirement as well as the tax year in which the retirement lump sum was received, to see if there has been a significant increase in contributions (see 6.2 of the draft Guidance Note). Earlier years will be considered to determine if there has been a significant increase. Hence, anyone who decides to use a lump sum as the means to pay significantly greater contributions, and does so by paying those increased contributions during the period set out in the HMRC Guidance Note will be caught by the recycling rules and the retirement lump sum will be taxed accordingly. Please note that the whole of the lump sum will be subject to the tax charge should it be proven that a breach has taken place.
Could this impact on my election to purchase Additional Pension?
Please note that this affects any member who is considering purchasing Additional Pension by lump sum or installments in the run up to retirement.
Whose responsibility is it to advise whether the recycling rules have been breached?
The new regulations for reporting recycling events stipulate that it is the individual’s responsibility to advise the scheme if there is a breach of the recycling rules. The Scheme for example will not know if the member has reinvested the lump sum into another pension scheme, which could breach the recycling rules. Similarly, the scheme would not know whether the member has deliberately pre-planned to use the lump sum to fund future pension benefits. The HMRC draft Guidance Note should be read very carefully. Please note the member has a responsibility to advise us of any breach in the recycling rules within 30 days of the date the recycling breach occurring.
What is not deemed as recycling?
The government has deemed that recycling of the lump sum does not occur where:
- A member has not pre-planned before receiving the retirement lump sum to use the lump sum to make a significantly higher contribution. This could be someone who has received a windfall such as an inheritance, redundancy payment or a lottery win who then decided to increase the contribution significantly. Such a person would still need to confirm that they have not set out to use the retirement lump sum to fund the additional contribution and that the greater contribution was a result of the windfall;
- Anyone who has a pattern of paying regular lump sum payments in previous years of an amount equivalent to that paid close to retirement. This would indicate to HMRC that the contribution paid is part of a person’s normal financial planning;
- The lump sum or combined lump sum(s) received by a member within a 12 month period does not exceed 1% of the Lifetime Allowance (LTA) i.e. £15,000 for the tax year 2006/2007;
- The additional contribution paid is less than 30% of the lump sum the member receives (i.e. if a contribution was a pre-planned way of using the lump sum to increase the retirement benefit, a member receiving a lump sum of £15,001 would breach the recycling rule if the contribution exceeded £4,500. A member receiving a lump sum of £45,000 would breach the recycling rules if the contribution exceeded £13,500);
- The member does not significantly increase contributions to their pension schemes in the lead up to retirement. As stated previously, any increase in regular contributions to a pension scheme in the two tax years leading up to retirement and the tax year of retirement itself will be scrutinised by HMRC where regular contributions increased by more than 30%. Hence increases to purchase Additional Pension could be caught by the recycling regulations, if the lump sum has been used (directly or indirectly) as the wherewithal to pay the amount of the significant increase in contributions; or
- Where the member’s benefits have already exceeded the Lifetime Allowance (LTA) which for 2006/2007 amounts to £1,500,000 and equates to a pension coming into payment from the Teachers’ Pension Scheme of £65,217 per annum (2006/2007), as such members are already subject to the LTA charge.
What action should a member take?
The issue of lump sum recycling is a complex one and members are advised to consult an independent financial advisor or HMRC if they think they are affected.
As stated previously, it is the member’s responsibility to advise the scheme if they have breached the recycling rule. A member must advise the Teachers’ Pension Scheme within 30 days of the breach, if the tax free lump sum has been used to increase the member’s pension benefits.
As a result of the new legislation, Teachers' Pensions has introduced a new procedure to identify and write to members where it appears that the recycling rule has been breached. Where a member is in breach of the recycling regulations (e.g. the member has requested that Additional Pension is to be funded from the lump sum and this exceeds 30% of the basic retirement lump sum), the member will not be able to sign the recycling declaration on the retirement application form. Under the new regulations the retirement lump sum will instead be "inversely commuted" (converted) to provide extra pension.
As stated earlier, if the member receives a self assessment return, the unauthorised payment must be included on the return. However, if the individual wants HMRC to work out the tax due, the return must be returned by the 30 September following the tax year end, rather than the 31 January deadline. If the return is sent back after the 30 September deadline, an individual must calculate and account for the tax due. If the individual does not normally receive a self assessment return, the individual must also notify chargeability by 30 September following the end of the tax year.
It should be pointed out that regardless of whether the recycling rules are deemed to apply or not, any contribution used to purchase additional pension may be tax relievable as a contribution and members will need to liaise with their local tax inspector of taxes accordingly.
Please note this is not a definitive guide to recycling of lump sums, but is aimed at making members aware of this issue and the potential tax consequences of breaching the recycling rules. This note is intended to give you a flavour of the issues and is not a substitute for advice. |
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