Friday, 28 March 2014


All the information in this blogpost is given in good faith, has been checked thoroughly, and is believed to be accurate at the date of publication – 28 March 2014. Paul Lewis accepts no responsibility for any consequences financial or otherwise to individuals who act on it. By reading on you accept this condition.

Up to £1500 free
Generally I don’t approve of using tax wheezes – evoidance as I call it – but this is one loophole which is built in to the current pension rules and has just been widened considerably. If you are aged at least 60 but under 75 and can get hold of a few thousand pounds (I know, I know) you can make £500 almost overnight. And you can do that up to three times with the same money. The gain is tax-free.

Here’s how it works.

             Open a personal pension plan (PPP) and pay in £8000.
             The Treasury puts in another £2000.That represents the basic rate tax you have paid to have £8000 left.
             The total in your fund is £10,000.

From Thursday 27 March a pension pot up to £10,000 counts as a small pot and can be taken out in cash as a lump sum.

             Immediately take out your small pot as cash
             The first 25% is tax free. That is £2500.
             The remaining £7500 is taxed at your basic rate.
             That will cost 20% which is £1500
             You are left with £6000.
             Add on the £2500 tax free and you have £8500. Even though you only put in £8000.
             Profit £500.

You can cash in up to three small pots, so you could make £1500 for nothing.

The calculation

Pay into a PPP
Treasury adds
Total in PPP
Cash in as small pot
Tax free cash
Taxable balance
less 20% tax
less original outlay
Do it 3 times

HMRC has what it calls ‘anti-recycling’ rules to stop people taking tax free cash and putting it straight back into a pension to get further tax relief on it. However, those rules do not apply until you take more than £12,500 of tax-free cash so should not apply to this process as even doing it three times releases only £7500 tax-free cash.

The scheme has been possible since April 2012 when the rules for cashing in ‘small pots’ first began. But before 27 March 2014 the maximum 'small pot' was £2000 so the profit was just £100 and you could only do it twice. So it was not worth it. By raising the limits to three pots of £10,000 each the Government has made the scheme much more worth doing. You can of course do it with any amount up to paying in £8000 which gives the maximum small pot of £10,000.

If you take three maximum lump sums it will count as taxable income of £22,500 and added to the earnings you need of at least £30,000 that will push you over the threshold for higher rate tax - £41,865 in 2014/15. Depending on your other income, two lump-sums or even one might do the same. That would mean some of the lump-sum is taxed at the higher rate. In that case the calculation is complex. You may make more profit but will have to wait longer for it. See the paragraph on higher incomes below. 

Lower incomes
The scheme also works for people who have low or no earnings. It is especially profitable if their income is low enough for them to pay no tax.

Anyone below the age of 75 can open – or have opened for them – a personal pension with up to £3600 in the fund. That means a payment in of £2880 and £720 tax relief is added by the Treasury. The whole lot can now be taken out instantly by those aged at least 60 – leaving a profit of £720 for a non-taxpayer or £180 for a basic rate taxpayer. Non-taxpayers will find the basic rate tax is deducted and they must claim it back. If the lump-sum takes them over the personal tax allowance of £10,000 (£10,500 for 66-74 year-olds), in which case they will only get part of it back. 

So a kind spouse or child or grandchild can open a personal pension with £2880 for a relative aged 60 to 74 who has low or no earnings and the person over 60 can then take the profit and repay the initial investment of £2880. It can only be done once a tax year.

Higher incomes
People who pay higher (40%) or top (45%) rate income tax can make more out of the scheme. If you pay higher rate tax the arithmetic is a little more complex. For your £8000 outlay you would get back just £7000 after paying 40% tax on the taxable £7500. That is a loss so far of £1000. But you can then claim further tax relief through self-assessment which will give you another £2000 which will be deducted off your tax bill. So the final net profit is £1000. For a top rate 45% taxpayer the initial loss is £1375 but the self-assessment claim will reduce the tax bill by £2500 leaving a net profit of £1125. The procedure can be done three times. But beware pension limits – see below.

The person opening the pension fund must be aged at least 60 and under 75.

They must earn at least as much as the pot or pots they pay into in the year they pay into them. Other income such as interest, dividends, a pension in payment, or an annuity does not count as 'earnings'.The exception is a single pot of up to £3600 including basic rate tax relief which can be opened by or for someone with low or no earnings.

Beware maximum limits
The maximum amount that can be put into a pension fund in a year is £40,000. If these payments take you over that limit in your pension input period you may face a tax charge on some or all of the money. If you are a member of a final salary scheme the rise in the value of your rights over the year will count towards your £40,000 limit. If you are at or close to your lifetime pension allowance of £1.25 million in 2014/15 further payments may not attract tax relief and you may be liable for a tax charge.

The Treasury payment may take some time to be credited which could delay the process. If you are a higher or top rate taxpayer you will make a short-term loss and will have to wait until you complete your self assessment form and pay your tax to make the tax saving.

Find a provider
Some platforms or insurance companies which offer personal pensions or SIPPs will be happy to do it for you. Some may charge nothing, others a modest fee especially for existing customers. One quoted me £120 including VAT for the whole job. Tell the firm you want to open an immediate vesting pension – or three if you can afford it and have the income needed.

The future
From April 2015 there will be no restrictions on taking a pension fund in cash and the age you can do so will fall to 55. So if you had you made no other pension contributions in the year you could put in £40,000 – the maximum pension contribution allowed in a year – and make £2000 instant profit. A higher rate taxpayer could get double that – £4000 – though there would be a delay before the profit was made. And for a top rate taxpayer the profit would be £4500. You could repeat the wheeze very year. So the Government will close this loophole before Pension Freedom Day in April 2015.

The facts in this blog have been checked with two top accountants and with pension providers and investment platforms. The Treasury has made it clear to me that officials recognised this consequence of the interim changes on 27 March. It seems that it does not intend to block this loophole in the current rules. But the Treasury will make sure that it cannot continue in its present form when the April 2015 changes begin. A spokeswoman told me "We are now consulting on how best to deliver the next step in our radical plan to let people withdraw their defined contribution pensions savings how they wish. This includes ensuring robust anti-avoidance measures are in place.” How small a pot will be caught by these measures will be the interesting thing to watch out for. 

Pension wheeze
Version 1.13
29 March 2014