Pension Recycling
The practice of taking a tax-free lump sum from your pension and reinvesting it back into a pension to gain further tax relief.
Pension recycling refers to taking a tax-free lump sum from your pension and then paying that money back into a pension to benefit from tax relief a second time. While this might sound like a clever strategy, HMRC considers it tax avoidance and has specific rules to prevent it. If HMRC decides that recycling has taken place, you could face a tax charge of up to 55% on the lump sum plus interest and penalties.
The recycling rule is triggered when several conditions are met: you take a tax-free lump sum, your pension contributions increase significantly as a result (by more than 30% of what they would otherwise have been), the additional contributions exceed 1% of the standard lump sum allowance, and the recycling was pre-planned. HMRC looks at contributions made in the period roughly one year before to two years after the lump sum was taken to determine whether recycling has occurred.
This does not mean you can never take a tax-free lump sum and also contribute to a pension in the same period. Normal, pre-existing contribution patterns are fine. The rules are aimed at deliberate schemes where someone takes tax-free cash specifically to recycle it back into pension contributions. If you are planning to take a lump sum and are also making significant pension contributions, it is worth discussing the recycling rules with a financial adviser to make sure you stay on the right side of HMRC's guidelines.