The Government announced last week that it was reducing a loophole that allowed pension holders to create a second tax free lump sum.
25% of most pension benefits can be taken as tax free cash, and the remaining 75% is liable to income tax. However some clever pension holders have been using a loophole to reinvest money taken from their pension to recreate a second tax free lump sum. The money which is taken out of the first pension (after tax free cash) is liable to tax. However this money is repaid immediately into a second pension and the tax paid is reimbursed through tax relief. By recycling money in this way, pension savers have been able to generate a second tax free lump sum.
The amount that can be contributed into a pension each year is called the annual allowance, and this is currently £40,000. However the new Pension Freedoms, introduced by the Chancellor in April 2016, mean that is was possible to access your pension flexibly using flexible access drawdown. If you took advantage of these new freedoms and took any taxable income out (over and above your 25% tax free lump sum), then the amount you can contribute each year will be reduced from £10,000pa to £4,000.
The aim of this change by the government, announced in the recent Autumn Statement, is to minimise the recycling of pension savings.
This process, also known as income recycling, means that a client takes a sum of money from one pension pot, and puts exactly the same amount of money back into a new pension fund. They will then be entitled to take a further 25% of this new pension fund as tax free cash (*). The annual allowance, or the amount that can be contributed to a pension in any tax year and get tax relief, is currently £40,000. However the new Pension Freedoms introduced in April 2015 meant that people were able to access their pension funds flexibly, and if you took any money out of a pension other than your tax free cash, then the annual allowance is reduced to £10,000 per year for this financial year, and £4,000 per year from April 2017.
It shouldn’t be forgotten however that there will still exist some ability to recycle income and generate a second tax free cash lump sum. Even if you took £4,000 taxable income each year and invested it back into your pension fund, after 10 years you would have a further £10,000 tax free cash to take from your pension fund (**).
If you would like to know about these changes to income recycling and second tax free cash lump sums, then please get in touch. You can visit our website www.best-pension-annuity.co.uk or call us on 020 33 55 4827.