How to make more money from your pension
In this video, Ed Bowsher looks at ‘pension recycling’. This is where you take money out of your pension pot, and then pay it back in, getting further tax relief from HMRC.
'Pension recycling is where you take money out of your pension pot, and then pay it back in, getting further tax relief from HMRC.
In this video, I explain how pension recycling will work under George Osbornes new pensions regime.
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So, the technique we're going to look at today is called pension recycling'. And the basic idea of pension recycling is that you take money out of your pension, and then you pay it back in.
On paying it back in, the tax man gives you an extra boost with a tax break so your money grows, and then you can withdraw it again and the circle keeps going around. Every time you pay it back in, you get a boost from the tax man.
Now pension recycling has been around for a long time. It's not a new thing, but the opportunities for it, I think, are growing now because of George Osborne's big pension revolution that he started to implement in April 2014, and there's going to be more changes coming through in April 2015.
And with all these new changes, pension recycling, I think, will become a more attractive opportunity for many people. So, just as a quick refresher on these pension changes going forward, there's really going to be three main ways for withdrawing money from your pension pot.
You'll be able to buy an annuity a good, old-fashioned annuity, which most people buy now and you buy an income for the rest of your life.
Or you could do something called flexi drawdown' very similar to something called flexible drawdown', which has been around for a while. That's where you leave your pension pot invested, but you withdraw varied amounts each year.
And then there's a new way to withdraw money from your pension it's called the UFPLS. That stands for uncrystallised fund pension lump sum'. Now, in many ways the UFPLS isn't that different from flexi drawdown, but it's better if you want to do this game of pension recycling.
So, you might want to ask, how are we going to do this? How is it going to work? How are we going to make money? Well, here's an example.
Let's imagine you've got £8,000 and you decide to pay it into your pension. You pay £8,000 into your pension pot and the tax man, assuming you're a basic rate tax payer paying 20% income tax, the tax man boosts your pension pot up to £10,000. So, you've got a nice £2,000 profit.
Now you want to get the money out from your pension pot so you can spend it. Well, you will have to pay some income tax, but with any withdrawal from your pension pot, there's always been the 25% tax-free lump sum.
So, traditionally, when you started withdrawing money from your pension pot, say you have a £100,000 pot, you could take out £25,000 and not pay any tax. The beauty of the UFPLS is that instead of taking all of that tax-free lump sum upfront, you can take a bit of it every time you withdraw money from the pension pot.
So, let's say you decide to withdraw £10,000 from the pension pot. Remember, we had £8,000 and the taxman kindly boosted it to £10,000 for us. Now, we take £10,000 out as a UFPLS. £2,500 is tax free. The other £7,500 we've got to pay income tax on, 20% of £7,500 is £1,500, so we end up paying £1,500 income tax £10,000 minus £1,500 income tax and we've got £8,500.
So, we've turned the £8,000 into £8,500 we've made a £500 profit simply by paying money into the pension pot and taking it out immediately. And you could carry on doing this year after year and making a nice little profit each year thanks to the taxman's little tax break.
Now, you might be thinking, "Wow, that's brilliant! I'm going to recycle hundreds of thousands of pounds through my pension each year and make loads of money." Well, sadly, George Osborne is wise to this and he said that once you start withdrawing money from your pension via a flexi drawdown or a UFPLS, you can only pay £10,000 back into your pension each year.
So, the potential profits are significant, but they are a bit limited. But that doesn't mean you shouldn't do it. £500 is £500. No one is going to turn their noses up at that.
And actually, if you go for an annuity, you'll still be able to pay in £40,000 each year. And the point about annuities is we're going to see new rules for annuities making them more flexible, meaning that you can get more variation in your annuity and income each year.
So, you could potentially buy an annuity with a big £40,000 payment one year and then run that through the recycling process just as I described and you'll make a much bigger profit than £500. It all sounds fantastic, and I think it is a very promising way to make a bit of extra money from your pension.
Having said that, there are a couple of caveats. One, HMRC has been on the prowl looking out for pension recycling in the past under the old rules, and so, when you've had big, big sums of money being recycled, HMRC has been able to claw some money back as long as it can prove that the money was being paid into the pension purely for recycling purposes.
Obviously, it's quite hard for HMRC to prove that, so it's only ever really clamped down when it has been large amounts of money going through the recycling process. I'd be very surprised to see HMRC start clamping down when the profit is only £500, but I could be wrong, and we could see the clamp downs happening for relatively small sums of money.
So, bearing that in mind, it's probably worth getting some professional advice before you start doing this. Don't just rely on my video. I think it's also worth getting professional advice, because it's very early days for the new world of pensions. I wouldn't be at all surprised if the government made further modifications to the bill that's going through parliament.
We may see other new clauses, secondary legislation, all the rest of it. Things may change, so if you're watching this video in summer 2015, it may already be out of date. So that's another reason why if you're thinking about doing this, thinking of doing some pension recycling, it's probably best to get some professional advice.
Having said that, I think it's a technique with real potential, it's worth knowing about, and I hope you've found watching this video useful for that reason. I'll be back with another video soon. Until then, good luck with your investing.