A pension ‘recycling’ loophole has been plugged by the government as part of new pension reforms.
Under current rules, nothing would stop a retirement saver drawing their 25% tax free lump sum from a pension and then reinvesting the money in another scheme to gain an uplift from extra tax relief.
Depending on the rate of income tax paid, the tax relief on the contribution could be anything between 20% and 45% on a maximum £40,000 paid into a pension each year.
To combat this tax trick, Chancellor George Osborne has plugged the legal gap by reducing the annual pension contribution allowance by £30,000 to £10,000 for retirement savers who are aged 55 or over and who have drawn down their tax-free pension cash already.
Abusing pension rules
“The possibility of abusing pension tax rules was a real worry for the Chancellor and needed some real thinking to stop the problem without disadvantaging under 55s from contributing to their pensions,” said a spokesman for pension provider AJ Bell.
However, pension providers and HM Revenue & Customs (HMRC) may have difficulties in establishing whether a retirement saver has drawn down 25% of their pension cash if they have multiple pots with different companies.
Pension providers do not have an overall view of the value of pensions or payments made by other providers, although HMRC should through data links with providers and tax returns.
“Ironing out this wrinkle could be a real issue for smaller providers,” said the spokesman.
Seeking clarity over reforms
Pension providers are also seeking more clarity over anti-avoidance measures the government intends to put into place from April 2015, as some small pot pension holders aged 55 and over can already access their funds.
The worry is new rules may come in between now and April 2015 that will put them in a position of breaching the rules and having to pay a tax penalty.
However, the Treasury has indicated that the government is aware of this problem and does not intend to take retrospective action against retirement savers for breaking new rules that they did not know about when making financial decisions.
To take full advantage of the current pension rules, savers and their financial advisors should work quickly to review their tax position and make immediate plans to transfer any cash between schemes or to draw down tax-free money.