How to prepare for pension recycling

The government has given more detail on how its pension reforms will work from next April. The most interesting aspect is that it’s now clear that there will be opportunities for ‘pension recycling’.

In other words, some folk will be able to take tax-free money from their pension, and then reinvest it back into their pension pot with a further tax break. So how might this work?

First, let’s look at the two main options that are being planned for those who want to withdraw large sums from their pension. If you’re over 55, your first option from April will be a ‘flexi-access drawdown fund’ – already christened ‘Fads’. This is similar to the ‘flexible drawdown’ we have today.

Say you have a £100,000 pot. You can transfer it into a Fad, then withdraw the money as and when you see fit. The first £25,000 (25%) you withdraw will be tax-free. After that, you’ll pay your marginal rate of income tax on further withdrawals.

If you die before you reach 75, your descendants can inherit your remaining pot, but they may have to pay a 55% tax charge on at least some of it.

Your other main option is to go for an uncrystallised fund pension lump sum (UFPLS). As with flexible drawdown, you have the freedom to withdraw as much or as little as you want. The main difference is that when you withdraw £10,000 from a £100,000 pot, £2,500 will be tax-free, while you’ll have to pay income tax on the remaining £7,500.

Then as you withdraw further cash, 25% of each withdrawal will be tax-free. The big advantage of UFPLS is that if you die before you’re 75, any remaining money in your pot won’t be liable for a ‘death charge’.

Once you start withdrawing, regardless of the method, you can only pay up to £10,000 a year into your pension (rather than £40,000). Still, that £10,000 is significant and may allow you to profit from ‘pension recycling’.

Here’s an example: say you’re already taking an income from your pension, and your total income is at least £10,000 a year. You can pay in £8,000 to your pension, and if you’re a basic-rate taxpayer, the tax office will boost that to £10,000. You can then withdraw this £10,000.

If you’re doing it via a UFPLS, you’ll get £2,500 tax free and pay 20% tax on the remaining £7,500. So you’ve had a £2,000 boost from HMRC and paid just £1,500 in tax, making a £500 profit. If you’re a low earner you may be able to make an even bigger profit, as you don’t have to pay any income tax on your first £10,000 in income.

There are several other similar opportunities for recycling, so it looks like we’ll see plenty of schemes along these lines from next April.

66% off newsstand price

12 issues (and much more) for just £12

That’s right. We’ll give you 12 issues of MoneyWeek magazine, complete access to our exclusive web articles, our latest wealth building reports and videos as well as our subscriber-only email… for just £12.

That’s just £1 per week for Britain’s best-selling financial magazine.

Click here to take advantage of our offer

Britain is leaving the European Union. Donald Trump is reducing America’s role in global markets. Both will have profound consequences for you as an investor.

MoneyWeek analyses the critical issues facing British investors on a weekly basis. And, unlike other publications, we provide you with the solutions to help you turn a situation to your financial advantage.

Take up our offer today, and we’ll send you three of our most important investment reports:

All three of these reports are yours when you take up our 12 issues for £12 offer today.

MoneyWeek has been advising private British investors on what to do with their money since 2000. Our calls over that period have enabled our readers to both make and save a great deal of money – hence our position as the UK’s most-trusted investment publication.

Click here to subscribe for just £12