So what is going on now and how does it work ?
In the 2014 budget when everyone was getting giddy over the new pension announcements not much was said about the immediate changes to the pensions "small pots " rule. Up until 27th March 2014 if you had an uncrystallised pension pot you could take it all as a lump sum, subject to tax and subject to the pot not being more that £2,000. You could do this twice.
Whilst we wait for the new tax year and for the major pension changes, the rules for small pots were changed with immediate effect on 27th March 2014. If you have reached the age of 60, you can now take up to three pension pots each worth up to £10,000, as lump sums without needing to buy an annuity. The first 25% will be tax free and the remainder of the lump sum will be taxed as earned income at your marginal rate.
So here's how the quirky tax loophole works for a basic rate tax payer.
1. Pay £8,000 into a personal pension and the pension provider immediately grosses this up by the basic rate of tax to £10,000.
2. Then ask the pension provider to immediately commute this to a pension lump sum under the new small pots rule .
3. The provider will immediately pay £8,500 - comprising £2,500 tax free in respect of the pension commencement lump sum and £6,000 which is the rest of the fund of £7,500 less basic rate tax of £1,500
4. Hey presto, like pulling a rabbit out of a top hat, as a basic rate tax payer you are better of by £500.
5. Do this three times, create three small pots and you have £1,500 courtesy of HMRC.
There is effectively an immediate return of £8,500 for an original investment of £8,000 - a £500 profit or a return of 6.25%
As well as having the available cash to do this, you must be over 60 and have UK relevant earnings of at least £30,000 for the tax year 2014/15 and you'll need to make sure the pension provider can accommodate this before the end of the tax year, they are under a lot of pressure getting all their systems ready for the new regime plus coping with a bottle neck of drawdown applications.
Of course this is all going to end come the new tax year, when HMRC tighten up this loophole but by then attention will then be on commuting any size fund as the new pension rules come into effect. Its sometimes nice to know that HMRC have scored an own goal, if only temporarily.
As always please seek professional tax and financial planning advice as there may be other factors influencing any outcomes.