Using pension recycling to help fund coronavirus shortfall

Pension schemes

It is not possible for clients to access their pension savings until the scheme rules allow it. This will usually (but not always) be when they reach 55. However, a personal pension fund is not permitted to give or lend money to the client’s company. But there may be a way to take advantage of pension recycling rules to effect an indirect arrangement.

Using the lump sum

If an individual is permitted to access their funds, they can look to take some of their tax-free lump sum. Once this is in their own bank account, they are free to do whatever they want with it - including making a loan to their company. In order to repay the loan, the company could agree to make employer pension contributions instead of repaying the individual directly.

Taking money out of a pension and then putting it back in is called pension recycling. HMRC has strict rules and limits in place on how much can be recycled before triggering special anti-avoidance rules. There are tough penalties for breaking these. But provided the rules are adhered to, pension recycling can be worthwhile.

Example. Jemma’s company, Acom Ltd, requires £20,000 for repairs to its premises. The bank will lend the money at an APR of 12%. The repayments would be £391 per month, that’s £28,152 in total. Acom can claim a tax deduction for the interest element, which will reduce the cost by £1,549, making the net repayments £26,603.

Instead, to pay for the repairs Jemma could draw a tax-free lump sum of £20,000 from her pension fund. To ensure her pension fund is worth no less as a result, Acom must pay £321 per month into Jemma’s fund. The total cost to Acom is £23,112 (£18,720 after 19% corporation tax relief). That’s a saving of almost £3,500 over a bank loan. It also produces some extra tax saving for Jemma and is more flexible.

If Acom can’t afford to pay the pension contributions (or make the loan repayments), but must have the new equipment, using Jemma’s pension fund as the source of capital can still work. She could take the £20,000 pension tax-free lump sum and lend it to Acom and allow it to pay pension contributions into her fund as and when it can. Care would be needed not to exceed the permitted amounts.

As a general rule the company contributions shouldn’t exceed 30% of the original lump sum in order to avoid triggering the pension recycling anti-avoidance rules, so be especially careful if the company is looking to make “catch up” payments. If triggered, the rules treat the lump sum as an unauthorised payment which can be very expensive.

No loss of tax-free cash

If Acom doesn’t recompense Jemma by paying into her pension it might seem that it, rather than Jemma, has benefited from her tax-free lump sum entitlement, but actually that’s not the case. The money from Jemma’s pension fund can be credited to her director’s loan account. This means that if and when it repays her there’s no tax or NI for Jemma to pay. If Acom doesn’t repay Jemma and she eventually sells the company or winds it up instead, £20,000 of whatever she receives out of the arrangement won’t be taxable. Therefore, Jemma won’t lose her tax-free lump sum, only delay the personal advantage from it.