The Member Receives a Lump Sum from the Pension Scheme

Dear colleagues

In case you are not aware of it I thought I should bring to your attention the fact that the Finance Act 2006 introduced new rules regarding the recycling of tax-free lump sums into pension scheme contributions. The government is concerned about people who use their tax-free lump sum received on retirement 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 criteria for determining whether there is recycling taking place are quite complicated but, broadly speaking, it will occur if:  the member receives a lump sum from the pension scheme  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 would otherwise have been. HMRC will generally take the view that a significant increase occurs where, because of the lump sum, the amount of the additional contributions are more than 30% of the contributions that might have been expected  the additional contributions are made by the member (or by someone else, such as an employer)  the recycling was pre-planned  the amount of the lump sum, taken together with any other lump sum taken from a pension scheme in the previous 12 month period, exceeds 1% of the standard lifetime allowance, i.e. exceeds £15,000 in 2006/07, and  the cumulative amount of the additional contributions exceeds 30% of the lump sum. Administering authorities will need to be alert to this potentially happening (e.g. where a member pre-plans to use the lump sum paid on flexible retirement as a means to pay / increase AVCs or buy added years in the ongoing employment). Scheme members who breach the recycling rules will be liable to a potential “unauthorised payments charge” of 40% of the lump sum paid and a potential additional unauthorised payment surcharge of 15%. A scheme sanction charge of between 15% and 40% may become payable by the administering authority if there is recycling.

As from 11th August 2006 HMRC have put the onus on the scheme member to notify the administering authority within 30 days of receiving the lump sum if they are planning to use it to break the recycling rules. However, in reality, it is quite unlikely that all scheme members will admit if this is the case. HMRC has, therefore, confirmed that if the scheme administrator considers it has reasonable grounds for doing so, they can ask for the scheme sanction charge to be discharged. The example provided in the HMRC guidance is where a scheme asks the scheme member to declare whether or not they are taking a lump sum with the intention of significantly increasing contributions to a registered pension scheme and the member declares otherwise, and then does use (and intended to use all along) the lump sum for recycling. It would appear wise for administering authorities to update their declaration forms to ask whether recycling is intended or, at least, to point out in the notes sent to members that HMRC will deem recycling of a lump sum to be an unauthorised payment resulting in tax penalties for the member (and potentially for the scheme). Further guidance on recycling is available at: http://www.hmrc.gov.uk/manuals/rpsmmanual/RPSM04104900.htm

Terry Edwards Head of Pensions