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BeeHive  >  BeeLines  >  Recycling of Tax-Free Cash

Recycling of Tax-Free Cash

BeeLiners will be aware, I’m sure, that the Chancellor’s Pre-Budget Statement towards the end of 2005 promised that new regulations would be put in place to stop so-called recycling of tax-free cash lump sums payable from pension arrangements.  Tax-free cash lump sums are themselves being re-named from 6th April and will be known as Pension Commencement Lump Sums (PCLSs) from that date.  The idea of the name change, I think, is to better describe what the lump sum is all about, but perversely it is the first time that tax-free cash lump sums have been able to be taken from pensions without the requirement for a pension to commence at the same time.  But that’s just me being picky again, so ignore that comment.

The idea is that the lump sums, which will continue to be tax-free, should not be re-invested in the pension scheme to ‘artificially’ generate further tax-free lump sum payments.  That’s what we were told at the time of the pre-budget stuff and it left us all wondering just exactly what it would mean in practice, you know like would we be required to pay out cash sums in marked banknotes or something?

Well, we need wonder no longer.  Her Majesty’s Revenue and Customs have today defined the new ‘recycling rule’ and scoped out just what it does and does not mean in practical terms.  I have decided to reprint the HMRC document here in full as I know it is something that generates quite a bit of interest among BeeHive users if our mailbox is anything to go by.  I think the way the HMRC describe this new rule here is well-written and pretty much self-explanatory.

Steve Bee

6 February, 2006

 

Guidance Note - on payment of pension commencement lump sums in respect of Registered Pension Schemes
Anti - avoidance rule
Recycling of pension commencement lump sums
    1. New recycling rule
    2. Background
    3. Description of the recycling rule
    4. When is recycling pre-planned?
    5. What is a "significant increase" in contributions?
    6. What is the cumulative basis on which the significant increase of contributions is based?
    7. Must the significant increase in contributions equal the amount of the pension commencement lump sum?
    8. How is the amount of the deemed unauthorised payment calculated?
    9. When does the deemed unauthorised payment occur?
    10. What tax charges apply to the deemed unauthorised payment?
    11. Scope of the recycling rule
    12. Examples of situations caught by the recycling rule
    13. When the recycling rule does not apply
    14. Examples of situations that will not be caught by the recycling rule
    15. Questions and answers
    16. Commencement of the recycling rule
    17. Registered Pension Schemes Manual

1. New Recycling rule

1.1 Finance Bill 2006 introduces an anti-avoidance rule for pension commencement lump sums paid to members of registered pension schemes – the “recycling rule”. It applies only where the member receives a pension commencement lump sum and, because of the lump sum, the amount of contributions paid into a registered pension scheme by or in respect of the member is significantly greater than otherwise would be and the member envisaged that this would be so.

1.2 his guidance explains how the recycling rule will work in practice and sets out circumstances where HM Revenue and Customs (HMRC) considers that it would and would not apply.

2. Background

2.2 Tax-free lump sums are typically paid when pension scheme members start to receive their pensions or annuities from their registered pension scheme. They can also be paid when members with money purchase pension saving enter into an “unsecured pension” arrangement, under which members can opt to draw income direct from their pension saving fund rather than using their fund to provide a pension or annuity. Under the new tax rules, this sort of tax-free lump sum is called a “pension commencement lump sum”.

2.3 The legislation that deals with pension commencement lump sums, in particular, is at paragraphs 1, 2 and 3 of Schedule 29 of Finance Act 2004. When a member of a registered pension scheme first draws on an amount of their pension saving, the pension commencement lump sum should not exceed 25% of the total value drawn. For example, a scheme member with £100,000 worth of money purchase pension saving in a registered pension scheme might decide, on reaching age 60, to draw on half of that saving, accessing the maximum pension commencement lump sum. In doing so, the member may take a pension commencement lump sum of £12,500 and the balance of the drawn fund (£37,500) is used to provide an income (for example, by purchasing a lifetime annuity) for the member.

2.4 Devices that are designed to boost the amount of the pension saving in a registered pension scheme through the artificial generation of tax relief funded by the pension commencement lump sum have become known as “recycling”. These devices exploit different parts of the tax legislation for pension schemes in Part 4 of Finance Act 2004. The new rule counters any such device by deeming an unauthorised payment to have been made when a pension commencement lump sum (or any part of it) is recycled.

3. Description of the recycling rule

3.1 A new paragraph, 3A, is inserted into Schedule 29 of Part 4 of Finance Act 2004 which provides for a pension commencement lump sum to be treated as an unauthorised member payment when that lump sum is used as part of a recycling device.

3.2 It should be noted that very few lump sum payments will be affected by this recycling rule. Pension commencement lump sum payments will not be caught if they are paid as part of an individual’s normal retirement planning.

3.3 The new rule applies where:

  • the individual receives a pension commencement lump sum,
  • because of the lump sum, the amount of contributions paid into a registered pension scheme in respect of the individual is significantly greater than it otherwise would be,
  • the additional contributions are made by the individual or by someone else, such as an employer.
  • the recycling was pre-planned.

3.4 But for the new rule to apply, the following must also apply:

  • the amount of the pension commencement lump sum, taken together with any other such lump sums taken in the previous 12 month period, exceeds £15,000, and
  • the cumulative amount of the additional contributions exceeds 20% of the pension commencement lump sum.

3.5 Example 1

3.5.1 An individual takes a pension commencement lump sum of £9,000 on 1st May 2006. This is the first time the individual has taken such a lump. As the amount of the lump sum does not exceed £15,000 and no other such lump sums were paid to the individual in the last 12 months, the recycling rule is not triggered.

3.5.2 On 1st November 2006 the same individual takes another pension commencement lump of £7,000 in order to significantly increase contributions to a registered pension scheme. Because the individual has received another pension commencement lump sum within the previous 12 months (the lump sum of £9,000 taken on 1st May 2006) the amount of the later lump sum of £7,000 must be aggregated with the amount of that previous lump sum. As the aggregate amount exceeds £15,000 (£9,000 + £7,000 = £16,000), the recycling rule is triggered.

3.5.3 The recycling rule applies to the second lump sum, resulting in a deemed unauthorised payment of £7,000.


3.6 Where the recycling rule is triggered, an unauthorised payment is deemed to be made to the individual by the pension scheme from which the pension commencement lump sum was paid.

3.7 The amount of the unauthorised payment is the amount of the lump sum but excluding any part of the lump sum that has been subject to a lifetime allowance charge.

4. When is recycling pre-planned?

4.1 One of the conditions for the recycling rule to apply is that the recycling must be pre-planned – the individual must envisage that contributions will be greater than they otherwise would be, because of the lump sum, at the “relevant time”.


4.2 When an individual takes the following steps:

  • decides to use a pension commencement lump sum as the means to increase contributions significantly to a registered pension scheme
  • receives the lump sum, and
  • pays the significantly increased contributions

pre-planning occurs at the time the lump sum is paid – the “relevant time”.

4.3 Alternatively, when an individual takes these steps:

  • decides to use a pension commencement lump sum as the means to increase contributions significantly to a registered pension scheme
  • pays the significantly increased contributions or otherwise arranges for them to be paid, and
  • receives the lump sum

pre-planning occurs when the significantly increased contribution is made – the “relevant time”.

5. What is a “significant increase” in contributions?

5.1 One of the conditions for the recycling rule to apply is that there is a “significant increase” in the amount of contributions paid

  • by the member to any one or more registered pension schemes
  • on behalf of the member to any one or more such scheme, for example contributions paid by the spouse or civil partner of the member, or
  • by an employer or employers in respect of the member to any such schemes.

(Including any combination of the above.)

5.2 HMRC will generally take the view that such a significant increase occurs where the amount of the additional contributions are more than 20% of the contributions that might have been expected.

5.3 The amount of additional contributions is measured on a cumulative basis to determine whether or not a significant increase has occurred. See section 6 below.

5.4 The underlying principle of whether or not there is a significant increase in the amount of contributions is, first, to establish the amount of contributions that might have been expected to be paid in the absence of a pension commencement lump sum and then compare that amount with the contributions that have been paid as a result of receiving the lump sum.

5.5 In the following examples, the pattern of contributions paid in previous years has been used as an indicator of the likely contributions that might have ordinarily been made had the pension commencement lump sum not been paid.

5.6 Example 2

5.6.1 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 or any other private pension contributions. Apart from the benefits from Employer A, the individual has no other pension saving.

5.6.2 Before leaving Employer A, the individual applied for and got another job with Employer B, who has a 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.

5.6.3 As the individual is simply paying contributions that would have ordinarily been paid as part of the membership of Employer B’s pension scheme, there is no significant increase in those contributions.

5.7 Example 3

5.7.1 A member’s annual contributions to registered pension schemes have been £10,000 a year for the last 10 years. In the year in which a pension commencement lump sum is received, the contributions are £15,000.

5.7.2 Based on the previous 10 years, the amount of contributions that might been expected is £10,000. So there is a significant increase in contributions as the increase of £5,000 is more than 20% of that amount (the limit is reached where the amount of the increase in contributions - £5,000 - exceeds £10,000 x 20% = £2,000).

5.8 Example 4

5.8.1 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 20% on the previous year’s contributions of £10,000 (£10,000 + 20% = £12,000).

5.8.2 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.

5.8.3 Although the member’s contributions have increased by more than 20% 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 greater than it would be in the absence of the lump sum.

5.8.4 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.

5.9 Example 5

5.9.1 In the same year that an individual receives a pension commencement lump sum, the contributions into a registered pension scheme for the individual increase from £10,000 to £15,000. The amount of the increase - £5,000 – means that the individual’s contributions have increased by more than 20% (£10,000 + 20% = £12,000).

5.9.2 However, the increase is not a significant increase as the individual’s contributions – paid both by the individual and the individual’s employer – are paid on a consistent basis. Since joining the employer 3 years ago the combined rates of the employee and employer contributions were 10% of pensionable salary and the individual’s salary increased by an average of 4% a year over that time.

5.9.3 In the year in which the individual took the lump sum, the contribution rate remained at 10% but the individual moved to a different position with the employer that meant that the individual’s pensionable salary increased considerably; from £100,000 to £150,000 a year.

5.9.4 Although the contributions for the individual have increased by more than 20% in the year in which the lump sum was paid, the amount of increase - £5,000 – does not represent as a significant increase. This is because the basis on which the contributions were paid remained the same.

5.10 Example 6

5.10.1 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.

5.10.2 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 £6,500.

5.10.3 The amount of contributions paid after the lump sum was taken - £7,000 - represents an increase of more than 20% on the contributions that were last paid in respect of the individual (£5,000 + 20% = £6,000). 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 20% (£6,500 + 20% = £7,800).

5.10.4 (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 is no pattern of contributions.)

5.11 Example 7

5.11.1 For the last three years, a member of a registered pension scheme has been required to pay annual contributions at a rate of 4% of pensionable salary. The member’s employer, historically, has paid contributions at a rate of 8% of pensionable salary but has not paid any contributions over the same period as the funding of the scheme allowed a contribution holiday.

5.11.2 The member, whose pensionable salary is £35,000, takes a pension commencement lump sum from a different scheme. At the same time, the results of a contribution review mean that the employer ends its contribution holiday and the rate of overall contributions must be increased. The employer’s contribution rate recommences at 9% of pensionable salary and the employees’ contribution rate is increased to 6%. This represents an increase in contributions of £3,850 – current contributions of £5,250 (£35,000 x 15%) less the previous contributions of £1,400 (£35,000 x 4%).

5.11.3 Although the new contribution rate relating to the employee - 15% of pensionable salary – means that the amount of contributions have increased by more than 20%, this does not represent a significant increase in contributions. This is because there has not been a material change in the basis on which the contributions are paid by and in respect of the member.

6. What is the cumulative basis on which the significant increase of contributions is based?

6.1 An individual planning to increase contributions significantly to a registered pension scheme when taking a pension commencement lump sum does not avoid the “significant increase” test by increasing contributions piecemeal or gradually over time.

6.2 Example 8

6.2.1 In the year in which a pension commencement lump sum of £20,000 is received by a scheme member (year 1), 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%, it is not a significant increase.

6.2.2 In the following year (year 2) the contributions increase to £11,000 – an increase of 10% on the usual annual contributions before the payment of the lump sum. This is not a significant increase as the £1,000 increase, in itself, is less than 20% of the usual annual contributions and the £1,000 increase and the increase in year 1, together, do not exceed the 20% 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).

6.2.3 In year 3, contributions increase to £11,500 – an increase of 15% on the contributions being paid before the lump sum payment. This is now a significant increase in contributions as, cumulatively, they have increased 30% over the amount of contributions that might be expected (year 1 increase of £500 + year 2 of £1,000 + this year’s of £1,500 = 30% of the usual annual contributions of £10,000).

6.2.4 However, the recycling rule is not triggered as the significant increase in the member’s contributions - £3,000 – does not exceed 20% of the amount of the pension commencement lump sum (lump sum of £20,000 x 20% = £4,000). See section 7 below.

6.2 5 (RPI is not required because the “current value” of contributions was £10,000.)

7. Must the significant increase in contributions equal the amount of the pension commencement lump sum?

7.1 For the recycling rule to be triggered, as well as there being a significant increase in contributions, the amount of that significant increase must also exceed a proportion of the amount of the pension commencement lump sum.

7.2 The amount of a significant increase in contributions must exceed 20% of the amount of the pension commencement lump sum.

7.3 Example 9

7.3.1 As Example 8 above for years 1 to 3.

7.3.2 In year 4 the member’s contributions increase to £12,000 – an increase of 20% on the usual annual contributions before the payment of the pension commencement lump sum.

7.3.3 This further amount of significant increase in contributions - £2,000 – together with the significant increase trigger in year 3 - £3,000 – means that the cumulative significant increase is £5,000. As this exceeds 20% of the pension commencement lump sum of £20,000 (£20,000 x 20% = £4,000) the recycling rule is triggered.

7.3.4 There is a deemed unauthorised payment, based on the amount of the pension commencement lump sum.

7.3.5 Note - this can only apply as the pension commencement lump sum is greater than £15,000.

8. How is the amount of the deemed unauthorised payment calculated?

8.1 When the recycling rule is triggered, the amount of the pension commencement lump sum is treated as an unauthorised member payment. However, if the lifetime allowance charge arose on any part of the pension commencement lump sum, that part of the lump sum is not treated as an unauthorised payment. This prevents a double charge under both the lifetime allowance charge and the recycling rule.

8.2 Normally, of course, pension commencement lump sums will be tax-free, but if a pension commencement lump sum is paid when part of the individual’s lifetime allowance is available, and the amount crystallised by the pension commencement lump sum exceeds the individual’s available lifetime allowance, the part that so exceeds the lifetime allowance is a chargeable amount for the purposes of the lifetime allowance provisions and will be taxable at 55%. This ensures that the part of a pension commencement lump sum that exceeds the individual’s lifetime allowance is treated the same as a lifetime allowance excess lump sum.

9. When does the deemed unauthorised payment occur?

9.1 The unauthorised payment is deemed to occur when all the conditions for the recycling rule to apply are met. So that date will determine the year of assessment in which the charge arises.

9.2 In cases where the significantly increased contributions are made after receipt of the pension commencement lump sum, then the date when all the conditions for the recycling rule to apply are met will be the date those significantly increased contributions are made. Where the contributions are significantly increased before the receipt of the lump sum, the date when all of the conditions for the recycling rule to apply are met will be the date of the payment of the pension commencement lump sum.

10. What tax charges apply to the deemed unauthorised payment?

10.1 The deemed unauthorised payment will trigger an unauthorised payments charge (section 208 of Finance Act 2004) and, possibly, the unauthorised payments surcharge (section 209). This means that the member will be liable to an income tax charge of up to 55%, based on the amount of the lump sum in question that is deemed to be an unauthorised payment.

10.2 The scheme administrator of the pension scheme that makes the deemed unauthorised payment will be subject to a scheme sanction charge (section 239) of between 15% and 40%, based on the amount of the payment.

10.3 Scheme administrators are able to apply to HMRC to ask it to discharge their liability in respect of a scheme sanction charge. Such an application can be made where the scheme administrator considers that the grounds for such a discharge are just and reasonable. Those grounds must be set out by the scheme administrator as part of the application.

10.4 Example 10

10.4.1 Following on from Example 9

10.4.2 The member’s lifetime allowance was available on all of the pension commencement lump sum and it was paid from a money purchase arrangement which had a value of £80,000 when the lump sum was paid. As the unauthorised payment, which is equal to the entire amount of the lump sum, represented 25% of the value of the member’s fund, the authorised payments surcharge applies in addition to the unauthorised payments charge. The member is liable to an income tax charge of £11,000, based on the amount of the unauthorised payment of £20,000 (the rate for the charge is 55%, which is made up of a rate of 40% for the unauthorised payments charge and a rate of 15% for the surcharge).

10.4.3 The scheme administrator of the scheme from which the lump sum is paid is liable to a scheme sanction charge. The initial liability is £8,000 (a rate of 40% based on the amount of the lump sum) but the amount could reduce to £3,000, depending on how much of the unauthorised payments charge liability is met by the scheme member.

11. Scope of the recycling rule

11.1 The recycling rule will apply where an individual envisages recycling a pension commencement lump sum by any means; from simply reinvesting the lump sum back into a registered pension scheme by way of a relievable pension contribution paid by the individual through to the use of any devices, schemes, arrangements and understandings of any kind, whether or not legally enforceable, that enable the effective recycling of a pension commencement lump sum.

11.2 The scope of the recycling rule includes any transaction entered into for the purposes of recycling. For example, the taking out of a loan to provide the wherewithal to pay a contribution into a registered pension scheme where that loan is to be repaid with the pension commencement lump sum.

12. Examples of situations caught by the recycling rule

12.1 Following are examples of where the recycling rule would apply.

12.2 Example 11 – Paying the pension commencement lump sum as a contribution

12.2.1 A 55 year old member of a registered pension scheme has built up a pot of £100,000 in a money purchase arrangement. The member has earnings of £75,000. The member is making contributions amounting to 10% of those earnings to another registered pension scheme in respect of a pensionable employment. The only other asset of note that the member has is the member’s family home, which is mortgaged. The member draws a pension commencement lump sum of £25,000 from his £100,000 pot, which is fully covered by lifetime allowance.

12.2.2 The member pays an immediate contribution of £25,000 into a registered pension scheme. The member is able to claim higher rate relief in respect of all of the contributions of £32,500 that the member makes in the tax year. HMRC would look to establish that the member had the intention at the time of taking the pension commencement lump sum of using that lump sum to make additional contributions and those contributions would be regarded as triggering the recycling rule. There would be an unauthorised payment of £25,000.

12.3 Example 12 – borrowing to facilitate recycling

12.3.1 An individual, who has not been in pensionable service nor made any private pension provision for the last 5 years decides to draw on a deferred benefit from a previous employment with the intention of using the expected pension commencement lump sum of £20,000 to fund a contribution to a registered pension scheme run by the individual’s current employer. Rather than wait for the lump sum, the individual takes out short-term borrowing of £15,000 in order to make an immediate contribution of the same amount, in time to meet the looming end of the current tax year.

12.3.2 The individual then receives the pension commencement lump sum, which enables the individual to repay the borrowing.

12.3.3 There would be an unauthorised payment of £20,000.

12.4 Example 13 – Employer contributions facilitating recycling

12.4.1 A 58 year old member of a registered pension scheme is the controlling director of a close company. The company makes annual pension contributions of £10,000 in respect of the member to the company’s pension scheme. The member has built up £1m in a separate money purchase arrangement. The member crystallises half of the value of the arrangement, taking a pension commencement lump sum of £125,000, and putting the balance into an unsecured pension arrangement.

12.4.2 The member then loans £125,000 to the company, which then makes a contribution of £125,000 to another registered pension scheme on behalf of the member (in addition to the usual £10,000 it pays to the company scheme).

12.4.3 HMRC would look to establish that there was the intention at the time the lump sum was taken for the additional £125,000 contribution to be paid and it will be regarded as caught by the recycling rule.

13. When the recycling rule does not apply

13.1 The recycling rule will not apply where any of the following applies:

  • where the amount of the pension commencement lump sum, together with any other such lump sums taken in the previous 12 months, does not exceed £15,000

or

  • the member receives a pension commencement lump sum, and
  • on a cumulative basis, contributions to one or more registered pension schemes are increased but not by a significant amount

or

  • the member receives a pension commencement lump sum, and
  • on a cumulative basis, contributions to one or more registered pension schemes are increased significantly but the significant increase does not exceed 20% of the amount of the pension commencement lump sum

or

  • the member receives a pension commencement lump sum, and
  • after receipt of that lump sum, the member decides to increase, significantly, contributions to a registered pension scheme or contributions that are paid in respect of the member are significantly increased.

14. Examples of situations that will not be caught by the recycling rule

14.1 The following are examples of where the recycling rule would not apply

14.2 Example 14 – payment of regular contributions

14.2.1 An individual is a member of two registered pension schemes. The member must pay a set rate of contributions as a condition of membership of scheme A and takes a pension commencement lump sum from scheme B. The ongoing contributions to scheme A will not trigger the recycling rule if there is no significant change to the amount of those contributions.

14.2.2 Similarly, if the member was also paying additional voluntary contributions to scheme A (or possible an entirely different scheme – scheme C), those contributions will not be caught by the recycling rule if there is no significant change to the terms under which they are being paid. Even where the amount of contributions varies from year to year, including a sharp increase in the amount of the next contribution after the payment of the lump sum from scheme B, provided the basis for the contribution does not change (for example, it is based of the amount of a bonus that is regularly paid from year to year) they will not be caught be by the recycling rule.

14.3 Example 15 – an inheritance

14.3.1 A member takes a pension commencement lump sum. Soon after, the member’s uncle dies, leaving the member an inheritance. Because of the unexpected inheritance, the member decides to make a one-off contribution into a registered pension scheme of the amount of the inheritance (or less). That contribution will not trigger the recycling rule.

14.4 Example 16 – contributions based on profits from a self-employment

14.4.1 An individual receives a pension commencement lump sum as part of retiring from an employment. The individual then concentrates on a self-employment and shortly after receiving the pension commencement lump sum pays a large single contribution into a registered pension scheme. That single contribution will not be regarded as caught by the recycling rule where it is clear that it was based on the amount of final profits of the self-employment for the year of accounts in which that contribution is paid.

14.5 Example 17 – genuine windfall

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

14.5.2 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.

14.5.3 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.

14.6 Example 18 – Employer buys an immediate commencement annuity

14.6.1 An individual has been in non-pensioned employment but has nevertheless made private money purchase pension provision in a registered pension scheme. Leading up to retirement from the employment, the individual asks for valuation quotes for the money purchase fund in order to consider what benefits will be drawn from the pension saving.

14.6.2 The employer decides to reward the individual with an annuity after all, which will be achieved by way of a registered pension scheme. The member takes a pension commencement lump sum from the private pension provision.

14.6.3 The contribution by the employer for the annuity is not a recycled contribution provided it can be shown that the amount of the intended contribution towards the annuity awarded by the employer has not been increased to any extent as a consequence of any agreement between the individual receiving the annuity and the employer that would have involved the individual using the pension commencement lump sum as means of increasing the employer’s contribution towards the annuity the employer is to provide for the individual.

14.7 Example 19 - financial settlements

14.7.1 A member takes a pension commencement lump sum from a money purchase arrangement and decides to take very little income from the remainder of the pension saving in that arrangement. This is because the member happens to receive a payment following a financial settlement (such as a settlement on divorce/dissolution of a civil partnership or a compensation settlement). The member decides to pay some of that financial settlement into a registered pension scheme. That contribution will not be regarded as caught by the recycling rule where it can be shown that the amount of the contribution does not exceed the amount of the financial settlement.

15. Questions and answers

Q1 Will this affect normal pension commencement lump sum payments?

A1 No – Very few pension commencement lump sum payments will be affected. Provided members of registered pension schemes are taking pension commencement lump sum payments as part of usual retirement planning in normal circumstances, and not intending to recycle them, the recycling rule will not apply.

Q2 Will scheme administrators be unwittingly caught by the recycling rule, resulting in a scheme sanction charge?

A2 No – a scheme member who intends to take a pension commencement lump sum as part of a recycling device will be required to inform the scheme administrator of that fact within 30 days of the date of the deemed unauthorised payment. (The Registered Pension Schemes (Provision of Information) Regulations 2006 (SI 2006/No XXXX)) will be amended in due course to require the member to provide this information.)

Scheme administrators are able to apply to HMRC to ask it to discharge their liability in respect a scheme sanction charge. Such an application can be made where the scheme administrator considers that the grounds for such a discharge are just and reasonable. Those grounds must be set out by the scheme administrator as part of the application.

Q3 Will recycling devices involving pension commencement lump sums paid to non-UK resident individuals be treated differently from those devices involving UK residents?

A3 No – the fact that the recycling device is being used by an individual who is not resident in the UK will not, by itself, be relevant to whether the recycling rule will apply. The unauthorised payments charge, unauthorised payments surcharge (if applicable) and the scheme sanction charge will also apply.

Q4 What information must be kept to satisfy HMRC that the payment of a pension commencement lump sum is not being used as part of recycling?

A4 Individuals should already keep documentation for self-assessment purposes. Also individuals should give appropriate information to scheme administrators and scheme administrators should keep appropriate records in accordance with the Registered Pension Schemes (Provision of Information) Regulations 2006 (SI 2006/No XXXX).

16. Commencement of the recycling rule

16.1 The recycling rule will apply in respect of all pension commencement lump sums that are paid on or after 6 April 2006, where those lump sums are used as part of a recycling device, regardless of when the significantly increased contributions are actually paid.

17. Registered Pension Schemes Manual

17.1 The Registered Pension Schemes Manual (RPSM) is an online resource providing guidance on the tax legislation for registered pension schemes and can be found on the HMRC internet site at www.hmrc.gov.uk/manuals.

17.2 The manual has been designed for technicians, scheme members, employers and scheme administrators; all of whom have differing needs and requirements in relation to registered pension schemes.

17.3 An explanation of the terms used in these Guidance Notes can be found in the Glossary to the RPSM

17.4 This Guidance Note will be incorporated into the RPSM.

Any research and analysis has been provided by us for our own purposes and the results of it are being made available only incidentally.

Crown copyright material is reproduced with the permission of the Controller of HMSO and the Queen’s Printer for Scotland.