Is it time to invest in a SIPP? Pension Choices under New Regulations
What is a SIPP, is it Right For You and What SIPP Products are Out There?
Self-Invested Personal Pensions (SIPPs) are one of the three main types of personal pension, and have been available since 1990. However, it is only since pension regulations were simplified in 2006 that this type of pension has really taken off. The wide choice of possible investments that can be included in these plans, and hence their tax advantages, make them attractive to those seeking greater control over their personal pension.
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This article seeks to answer the question ‘What is a SIPP?’, compares them with other personal pension types, shows the advantages and disadvantages of each, and looks at the things to consider when deciding on the best home for your precious pension. It is important to be aware that, as is the case with most financial products, there is no one pension type that is the best for everyone, and that individual circumstances must always be considered before making any changes.
1) What is a SIPP?
Before detailing the definition of a self-invested personal pension, and where it fits into the overall pension landscape, it is worth summarising the main types of pension available in the United Kingdom. These are:
• The state pension which is provided to all those eligible, subject to payment of sufficient National Insurance contributions; • Final salary pensions, or ‘defined benefit’ schemes – these usually guarantee a percentage of the last salary before retirement, but are now becoming scarce; • Personal pensions, also known as ‘money purchase’ or ‘defined contribution’ schemes – these include schemes run by employers where both employer and employee contribute, and can be considered as investment policies, designed to provide an income in retirement.
The self-invested personal pension is one of the three types of personal pension. These three types can be briefly compared as follows:
a) Self-invested personal pension: offers a very wide range of investment funds and investment choices, and allows a high level of control to the investor. May be more suitable for larger funds. No regulated limit on charges. b) ‘Standard’ personal pension plan: usually limited to the investment funds chosen by the provider. No regulated limit on charges. c) Stakeholder pension: created to provide confidence following the pensions scandals of the late 1980s, stakeholder pensions can only charge up to 1.5% of the fund value for management, dropping to 1% after ten years. This may mean a more restricted range of funds than a standard plan. Stakeholder pensions are also bound to accept very small contributions.There is a clear trade-off between flexibility and cost. For example, a stakeholder pension is offered at a relatively low cost, but will not allow you the wider range of investments available with the other types. It should be noted that there is no clear trade-off between cost and performance. Investment is not an exact science and, much as we would wish it to be so, no one person or firm can guarantee a good performance from a personal pension.
2) How does a SIPP compare with other types of personal pension?
Personal pensions have been in existence since 1988, when they were introduced to provide an accessible method of saving for retirement outside the limited provision of the state pension. The average age of the population of the UK is increasing, and there is great concern that there will simply not be enough people of working age to support all those in retirement. Personal pensions are part of the drive to transfer responsibility for funding retirement to the individual, and to encourage people to save. Recent changes to the regulations now provide more flexibility and greater control for those saving for their retirement in a personal pension.
There are no longer any real differences between the various types of personal pension when it comes to providing income at retirement. However there is a big difference when making contributions. Here, the major advantage of a self-invested personal pension is its high level of flexibility, and the control that the investor can have over their exact investments. While the charges may be more than for a ‘standard’ or stakeholder pension, there will be access to a much wider range of funds and investment types.
The full list of investments that may be placed in the tax shelter of a self-invested personal pension is currently as follows:
• Recognised stocks and shares, and in some cases unlisted shares • Investment trusts, including UK Real Estate Investment Trusts • Venture capital trusts • Commercial property (note – not residential property) • Hedge funds • Deposit accounts • National Savings and Investments products • Traded endowment policies • Futures and options from an FSA-recognised exchange • Depositary interests – these are UK-registered securities that enable electronic trading in the UK in non-UK incorporated shares • Unit trusts and open-ended investment companies (OEICS) • Insurance company funds • Contracts for differences (CFDs)
Not all providers will offer all of the above investments – this is an important thing to check when selecting a provider.
This wide range of investments gives a possibility of much greater returns, as risk can be spread across a broad portfolio. It is also possible to use the tax benefits to generate extra value in the pension.
The important point to note is that this is a SELF-invested personal pension – this means that it needs a much higher level of involvement, whether from the owner or from a financial adviser, or both. While it is perfectly possible to manage your own pension investments, the consequences of poor investment performance could be serious and so this route is definitely not for novices in investment. As greater flexibility can mean higher management and setup costs, these plans may be better suited to those with larger pension funds, and with sufficient time before retirement to recover from any investment losses.
Although there is no difference between the forms of personal pension when it comes to taking an income, it is worth a brief summary of the current situation as there has been a recent change. Retirement age has always been flexible with personal pensions, but until 6 April 2011 it was effectively compulsory to buy an annuity on or before your 75th birthday.
This has now changed. The option of ‘income drawdown’ that was available before 2011 has now been widened to include ‘flexible drawdown’, and the requirement to buy an annuity has been abolished. Flexible drawdown is only available to those who can demonstrate a secure pension income of at least £20,000 per annum, but the removal of the annuity requirement is available to all. The rules on income drawdown levels have also been revised with different limits.
3) What are the different types of SIPP pension?
SIPPs are available in different ‘grades’, attracting different charges, depending on the range of
investment types and funds that are permitted. The two main subcategories are: • ‘full’ – allows access to the fullest range of investment types, and is suitable for those who want to invest in more complex assets or in a wider range of assets than are available in a standard personal pension. This type of plan can only be set up and managed with the assistance of an accredited financial adviser. • ‘supermarket’ – so named because the providers also offer online fund supermarkets, this type of plan does not require the involvement of an accredited financial adviser. The customer will have to agree with the provider that he is setting up the account on an ‘execution-only’ basis, absolving the provider from any involvement in the investment decisions or their consequences. Supermarket SIPPs can offer considerable savings by allowing investors to make their own decisions without paying for financial advice.
It is also possible to set up another type, which covers more than one person. Known as ‘family SIPPs’, these schemes can cover not only relatives but also business partners who are investing jointly in property. Such plans are very useful for passing wealth without inheritance tax liability, and for reducing costs when changing partners in the ownership of specialist products. These are a specialist product and so should always be used in conjunction with appropriate advice.
You may hear other terms used as the pensions industry produces more types of plan – these usually refer to the different types of investments allowed by each provider.
4) What are the contribution limits?
Like all other personal pensions, there is a limit to the maximum annual investment that can be made in a self-invested personal pension in order to retain the tax advantages. As of the current tax year the limit is the greater of:
• 100% of an individual’s salaried income, subject to a maximum of £50,000 or • £3,600 (for those with no salaried income)
It is possible under some circumstances to carry forward unused limits from the three previous tax years. Tax relief is available to UK residents and applies to earnings – note that income from investments, rentals and pensions is not eligible.All contributions within these limits are eligible for tax relief – this is the biggest advantage of investing in a personal pension as opposed to other forms of saving. Contributions are ‘topped up’ by the basic rate of income tax, so at current rates every £80 paid in is worth £100 once in the pension. Higher rate tax payers use their tax return to claim the additional relief, although care should be taken to ensure that contributions are fully eligible. Tax relief is available to all those under 75, although in practice it is unlikely that anyone over that age would be contributing to a pension.
Benefits may not be taken before the age of 55 (recently increased from 50). Finally, there is a lifetime limit on the amount that can be held in all types of personal pension – funds over 1.8 million pounds may be subject to an additional tax charge. This is clearly only a problem for high earners.
5) Is a SIPP suitable for me?
It is important to review old pensions regularly, especially if you have several schemes left with a variety of previous employers. Some older schemes have much higher charges than new schemes, or fall into the dreaded ‘zombie fund’ category – so called because the fund has no direction, moves very slowly and is in poor financial health. However other schemes such as final salary pensions or those with high exit penalties may be best left where they are.
If you decide that there is a need to transfer an old scheme or to start up a new one, the advantages of transferring pensions or assets into a SIPP include:
• A wider range of investments than a standard pension, as the plan can contain assets such as shares, commercial property and other products; • The ability to generate extra income by using the tax advantages of the plan; • A greater level of control over the investments.
Disadvantages can include:
• Higher charges – there is no point in using a complex plan if you are not going to take full advantage of its flexibility. Many providers have a startup charge as well as charges for changing investments. • Loss of benefits from the previous scheme – the decision to change can be irrevocable so it is important to have a full understanding of all the issues; • Exit penalties from the previous scheme, which can be very high in some cases.
Finally – a note of caution. The popularity of self-invested personal pensions has led to many companies offering them to attract new investment. However, some of these schemes do not offer the full advantages – i.e. the wider range of investments – but have no hesitation in charging the increased fees. In addition, there have been cases where these plans have been sold to those whose funds are not sufficient to make the most use of them, or to those who really only need the simpler product offered by a standard personal pension or a stakeholder scheme.
In summary, SIPPs are not the answer for all pensions, but they can be very worthwhile for those with a suitable amount to invest, sufficient investment knowledge and a full understanding of all the issues involved.
Your pension is one of the biggest investments that you will ever make, and as it often contains much of the proceeds of your working life, it deserves all the attention and effort that you can give to it.