Pension recycling

We explain the potential tax benefits and the limitations of taking money out of one pension to re-invest in another.

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Not to be confused with pension transfers, pension recycling can be a straightforward way to move money between schemes and maximise your tax relief. And who doesn’t want extra bonus money for free?

The basic idea is that you take money out of one pension and use it to pay into another scheme. This may seem counterintuitive – after all, why would you take money out of your pension only to put it straight back in? Well, it can offer certain tax benefits like double tax relief, provided you stay within HMRC’s pension recycling rules.

What is pension recycling?

Pension recycling is when you take money out of your pension and use it to make further contributions to another pension pot, benefiting from maximum pension tax relief.

Basically, you can recycle any sort of pension income, such as money you’ve withdrawn flexibly from a defined contribution pension (flexi-drawdown pension recycling).

However, pension recycling is mostly used to recycle some (or all) of your tax-free lump sun, which applies to the first 25% of a pension pot that you can withdraw from the age of 55 (rising to 57 in 2028) without paying income tax.

How do I recycle my pension?

On the surface, recycling your pension is fairly straightforward. You simply take money out of one pension and pay it into another scheme, benefiting from the tax relief that is applied to pension contributions.

To benefit from tax relief on pension contributions, you’ll need to have some form of earnings or income other than pension income, such as employment income or certain benefits that would make you a taxpayer.

Expert comment - What are the tax benefits of pension recycling?

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George Sweeney

Deputy editor

By recycling money taken from your pension, it means you can receive tax relief on the funds twice. This is because you will already have received tax relief when you first paid the money into your pension. And by taking out money and putting it into another scheme, it's possible to get another bump from tax relief.

Doing this means you can continue tax-efficient growth of your pot. And if you're recycling money from your tax-free lump sum, you won't have had to pay income tax on that money either. If you are recycling taxable income from your pension, any income tax you pay could be offset by this next round of tax relief.

When you get into the weeds of tax avoidance and loopholes, it can be worth getting professional advice to make sure you don't break any rules. HMRC has some guardrails in place to try and stop people gaining an unfair advantage by abusing the system. But, efficiently managing your tax liabilities can be a useful part of retirement planning.

What are the pension recycling rules?

HMRC’s pension recycling rules apply to recycling your tax-free pension commencement lump sum (PCLS). There’s a different set of restrictions for flexi-drawdown pension recycling.

According to HMRC, the rules are designed to prevent people exploiting pension tax rules to generate artificially high amounts of tax relief.

You’ll fall foul of HMRC’s rules if all of the following apply:

  • You’ve taken a tax-free lump sum.
  • It deems the recycling was pre-planned
  • You take more than £7,500 in tax-free cash (when added to any tax-free cash from the previous 12 months)
  • The amount of all additional contributions exceeds 30% of the tax-free money.

Some of the points above are clear-cut (whether you took out a tax-free lump sum, and whether this exceeded £7,500, for example). But others are more open to interpretation – such as whether recycling was “pre-planned”.

HMRC has to prove that pre-planning took place, and HMRC acknowledges that it assesses each potential breach of recycling rules on a case-by-case basis. It has a few examples in its Pensions Tax Manual.

What happens if I follow the rules incorrectly?

If HMRC finds that you have met all of the criteria in the rule checklist above, you will be deemed to have made an “unauthorised payment” into your pension.

If this is the case, HMRC can impose a charge of up to 70% of the value of your tax-free money.

You can, of course, try to avoid breaking the rules by keeping any additional pension contributions within the amounts outlined in the rules.

But, even if you exceed them, it doesn’t automatically mean you’ve broken the rules. The other factors come into play around intent, and whether your contributions are greater than they otherwise would be.

That said, it’s also possible to get caught out by accident. If you’re considering recycling some or all of a pension tax-free lump sum into another pension, it’s a good idea to seek regulated financial advice.

What are the rules for flexi-drawdown pension recycling?

HMRC’s PCLS recycling rules only apply to money you recycle from a tax-free pension lump sum. They don’t apply to taking taxable, flexible income from a pension drawdown scheme and paying it into another scheme.

However, there are other restrictions in place that limit how much money you can recycle in this way, known as the Money Purchase Annual Allowance. This kicks in if someone with a defined contribution pension scheme either:

  • Starts to draw an income from their pension via pension income drawdown.
  • Takes money from their pension via “Uncrystallised Funds Pension Lump Sum (UFPLS)” withdrawals. This is where, rather than being able to withdraw 25% as a single tax-free lump sum, you leave your money invested and take out smaller lump sums. The first 25% of each smaller lump sum you withdraw is tax-free, the remaining 75% is taxable.

For most people paying into a pension there is an annual contribution allowance of £60,000 (or the level of their annual salary, if this is lower).

While you can contribute more than this per year, anything above the allowance won’t benefit from tax relief. The Money Purchase Annual Allowance reduces the limit to just £4,000, which restricts the amount of pension income you’d be able to recycle and benefit from tax relief.

Does pension recycling apply to all types of pension income?

Technically, there’s nothing stopping you from recycling types of pension income other than those we’ve covered above, such as monthly income from an annuity or a workplace pension. And accessing your money in these ways doesn’t trigger the Money Purchase Annual Allowance or any other restrictions on making further contributions. But, in practice, these schemes offer much less flexibility over how much you can take out (and re-contribute) compared with drawdown or UFPLS.

Pros and cons of pension recycling

Pros

  • The opportunity to gain extra tax relief
  • Legal way to maximise tax relief on pensions
  • Can be a tax savvy move in retirement

Cons

  • HMRC has rules that must be followed
  • It can be confusing to navigate without support
  • Potentially high fines if you break the rules

Bottom line

Pension recycling can be a useful way to maximise tax benefits and boost your pension pot. But it’s a legal grey area and it won’t be right, or possible, for everyone. And a misstep could risk a big financial penalty that far outweighs any tax benefits.

If you are tempted to try recycling part of your pension or tax-free lump sum, regardless of your reasons, make sure you’re aware of HMRC’s rules and restrictions. Consider getting some professional advice if you still don’t know where you stand.

Frequently asked questions

Pensions are long-term investments. You may get back less than you originally paid in because your capital is not guaranteed and charges may apply. Keep in mind that the tax treatment of your pension and investments will depend on your individual circumstances and may change in the future. Capital at risk.
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To make sure you get accurate and helpful information, this guide has been edited by George Sweeney, DipFA as part of our fact-checking process.
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Ceri Stanaway is a researcher, writer and editor with more than 15 years’ experience, including a long stint at independent publisher Which?. She’s helped people find the best products and services, and avoid the pitfalls, across topics ranging from broadband to insurance. Outside of work, you can often find her sampling the fares in local cafes. See full bio

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