Recycling your pension

The income recycling regulations put a limit of £10,000 per annum on contributions that can be put back into a personal pension after flexible benefits have been drawn from a pension.

Paying money back into a pension will generate extra tax relief, provided that the contributions do not exceed earned income in the same tax year. The recycled contributions will also generate more tax-free cash and can also shelter the income that has been recycled from inheritance tax if an appropriate trust is used.

The limits on income recycling for individuals with no earned income will be £2,880 per annum, which will generate £720 of tax relief for basic rate tax payers and £900 of new tax-free cash.

If an individual still has earned income, they should be able to recycle, in most cases, up to 100 per cent of that income back into a new plan up to £8,000 per annum. This would generate £2,000 of tax relief for basic rate tax payers and a further £2,500 of tax-free cash for every year this was done.

Recycling will be extremely beneficial for pension holders who are in drawdown schemes. The 2011 Finance Bill introduced a death tax of 55 per cent on any money left in these schemes at point of death, so drawdown holders who are not currently withdrawing the maximum pension income may wish to consider taking maximum withdrawals and recycling into a new scheme with zero per cent tax on death.

The Government has also announced that this 55 per cent tax on death will be reduced to a slightly fairer 40 per cent and the legislation is expected to go through next year.

Tax-free cash recycling is slightly more complicated and there are also limitations as to what HMRC allows, but in essence it is the process of reinvesting part of a tax-free pension lump sum back into a new pension arrangement to generate further tax relief and a lump sum in the same way as pension recycling.

Great care should be taken with tax-free cash recycling, as a breach of the rules will trigger an unauthorised payment charge of 40 per cent, as well as potential scheme sanction charges and de-registration charges.

David Hill is a chartered financial planner and independent investment adviser at Hills Financial Planning, 15 Agnew Street, Larne. He can be contacted on 028 28276814, email [email protected] or see www.hillsfinancialplanning.co.uk