George Osborne receive the gratitude of many after he changed existing pension rules that required individuals starting their retired life to buy an annuity. Annuities– where you offer all your pension fund to an insurance provider in return for an income for life– are (or were) among one of the most disliked of all pension rules.
In liberalising the pension market, Osborne opened a potentially outstanding tax loophole. It is called “pensions recycling” by the market, and what follows is exactly how it functions.
Amongst the instant adjustments Osborne revealed were those to the “trivial commutation” rules. If you had £ 2,000 or less in any pension pot the current rules permit you take it as cash in one go, without requiring you to acquire an annuity. The rules now increase that amount from £2,000 to £10,000 – so the recycling loophole looks like this :
Why not put £10,000 straight into an income drawdown pension policy – a high rate tax payer will obtain 40% tax relief, so it merely sets you back £6,000 to have £10,000 in your pension pot. At the start of the next tax year take it all out – 25% of this will be tax free. Then place the remaining £7,500 back into a pension pot. This will be a tax neutral transaction as any tax paid on taking the 75% out will be reclaimed when it is put back in to your pension. The next year cash it in again – you will be entitled to a further 25% tax free amount (£1,875) — then put the remaining 75% back into a pension again and follow the same process again. Keep doing this each year until you have taken as much of the fund as possible in a tax efficient way.
The Financial Service Act 2006 presented “anti-avoidance arrangements to prevent tax free lump sums taken from a pension being used to fund a further pension thereby gaining further tax-relief on the original pension tax free lump sum. However there have never been any restrictions on recycling pension income. Previously the pension guidelines restricted customers on just how much pension income they can take from their fund each year, however the brand-new guidelines get rid of all income limitations, so it will certainly be feasible to take it all of it in one go if you desire.
The problem is that pension liberalisation has actually dramatically increased the interest for reusing pension income to create further tax free lump sums for the future. Will the UK government permit this scenario to continue, or will they feel it is an abuse that needs addressing ?
Skilled pensions expert Bob Cook of Best Pension Annuity as well as its sibling business Best Drawdown Pension stated “Lots of consumers have actually been reusing earnings from their pension for a number of years, and also Her Majesty’s Revenue and Customs (HMRC) have actually been well aware of the method. For those clients currently recycling the yearly allocation is £40,000 each year – 4 times the brand-new limitation, if those consumers do not alter their existing pension arrangements when the brand-new regulations come into force then they could maintain the £40,000 allowance, while consumers brand-new to recycling will certainly be restricted to £10,000.
“Nevertheless if there is a considerable rise in clients deciding to recycle pension income, then that could urge HMRC to look for methods of banning the technique. My understanding is that the Treasury is caught in between wishing to liberalise pension guidelines on the one hand, rather than making significantly more work for themselves, by potentially needing to implement a whole lot of brand-new guidelines to put an end to a misuse of the system.
“It is necessary to bear in mind that pension income recycling is presently lawful and also absolutely nothing yet in the brand-new pension regulations will rule it out. I think that whatever future regulations are implemented, it could be hard for HMRC to make pension recycling vanish completely”.