Self-Invested Personal Pensions (SIPP)

A Self Invested Personal Pension, or SIPP, is an upmarket form of a personal pension plan that offers savers a number of attractive features such as increased control and flexibility of their pension fund and its investments.

Introduced in 1989, SIPPS were aimed at wealthier individuals, i.e. those with pension funds over £200,000.

However, increasing competition and changes in legislation in recent years has brought charges down and made them more accessible to clients with lower fund values.

Increased accessibility, control and a wider range of investment options such as property purchase are just some of reasons why an increasing number of people setting up a pension for the first time are choosing a SIPP instead of a traditional company pension plan.

SIPP pensions have a number of advantages over more basic personal pension plans.

One of the major benefits is the greater amount of control and flexibility they offer.

Savers are given the option of choosing and managing their own investments with the help of an independent financial adviser.

SIPPs: extensive range of investment options

Unlike conventional pension schemes, SIPPs offer an extensive range of investment options (there are many types of financial asset can be invested in a SIPP). They also provide investors with tax-efficient savings for when they retire, and offer a greater choice of pension benefits for their dependents or spouse when they die.

In addition, a person who takes out a pension scheme with an insurance company who have badly performing funds will be charged a fee to close that scheme and switch to another company.

However, with a SIPP contributions can simply be redirected to a better performing fund.

Consolidation – Pension transfer

Another major advantage of a SIPP is that it allows people to transfer any existing pension schemes and investments they may have into one pension fund. This is why a SIPP is sometimes refereed to as a pension wrap or wrapper.

By consolidating their retirement savings in one place, savers can benefit from easier management of their investment portfolio and reduce the charges associated with their other pension plans. There are also companies who provide improved terms for larger pension fund investments.

Before any transfers are carried out, it is important for people to check whether there are any valuable benefits in the existing schemes that would be lost on transfer. The costs of transferring must also be taken into consideration.

SIPPS offer increased tax benefits on contributions than most traditional pension plans. Basic rate tax relief of 20% applies to any contributions made into a SIPP. This means that basic tax rate payers who wish to invest £10,000 in a SIPP only need to contribute £8,000 in the current tax year as the remaining £2000 (20%) will be topped up by the taxman (Inland Revenue). The same applies for monthly contributions.

Current government income tax bands

Tax relief on employer pension contributions

Contributions to your SIPP can also be made by your employer, even if you do not make any contributions yourself. Any employer contributions to the SIPP are paid gross, or in other words tax-free. However, there is no tax relief on transfers from other pension funds into your SIPP.

Tax relief on employee pension contributions

Companies usually take the pension contributions from their employee’s pay before deducting tax (but not National Insurance contributions).Tax is only paid on the pay that’s left, so whether you pay tax at basic or higher or additional rate you receive the full relief straightaway.

However, some employers use the same method of paying pension contributions that personal pension scheme payer’s use, whereby income tax is taken on your earnings before any pension contribution, but the tax is claimed back from the government by the pension provider at the basic rate of 20 per cent.

Higher rate payers can claim the difference through their tax return or by telephoning or writing to their tax office, while additional rate taxpayers must claim the difference through their tax return.

With SIPP pensions there are two main charges involved – a set-up fee and an annual administration fee.

The initial charges for setting up a SIPP are typically between £200 and £400, while the annual administration cost usually ranges between £300 and £900, depending on the provider.

Charges for your SIPP

These charges are usually made clear when applying. Customers who set up a SIPP with a limited range of options such as shares, funds and cash, may find that no set-up fee is required, only a modest annual fee.

Other possible charges include:

• Transfer charges – the cost of moving funds from other pensions into a SIPP
• Dealing charges – cost of buying and selling investments (other than property) within a SIPP.
• Exit charges – cost of transferring a SIPP elsewhere
• Property purchase – pension trustees charge for their services when buying a commercial property, in addition to usual legal and surveyors fees.
• Fees for additional advice or expertise – an independent company/financial adviser can charge the equivalent of between 0.5 per cent and 1 per cent per year of the value of the pension fund for providing expertise in managing a SIPP and its investments.

Setting up a SIPP pension can be done online. A regulated adviser can help in selecting a suitable wrapper, which must be set up with an insurance company or specialist SIPP administrator to provide the pension tax shelter.

Once established, a lump sum, regular contributions or pension transfers are invested into the SIPP cash account. The capital in the account is then used to purchase a balanced spread of investments, with the help of a regulated adviser. This could include planning for a commercial property purchase within the SIPP.

To open a SIPP, investors must be a UK resident and under the age of 75.

Unlike other personal pension schemes, a SIPP can hold a wide range of investments, which grow virtually tax free. However a SIPP with a wider level of investment choices may come with higher charges and therefore it is important to check the charging structure of a SIPP.

Permitted SIPP investments include

• UK stocks and shares including shares listed on the Alternative Investment Market (AIM)
• Overseas stocks and shares quoted on a Recognized Stock Exchange
• Unquoted shares
• Deposit accounts (in any currency providing they are with a UK bank or building society)
• Government securities and other fixed interest stocks
• Unit trusts
• Open ended investment companies (oeics)
• Investment trusts
• Insurance company funds
• Commercial property (such as offices, shops or factory premises)
• Traded endowment policies
• Permanent Interest Bearing Shares (PIBS)
• National Savings products
• Warrants

Investing in commercial property

One of the main attractions of a SIPP is that it can be used to invest and develop commercial property, such as offices and shops. A SIPP can borrow up to half the fund value it already holds to purchase commercial property. The rent from the property can be used to cover the mortgage repayments or, if there is no mortgage to be paid, it can remain in the SIPP fund and used for other investments.

Investing in commercial property is a particularly popular investment option for small businesses owners, as it allows them to purchase premises for their company through their pension funds. Using a larger pension fund in this way also offers several attractive tax benefits, such as:

• The rental income paid into a SIPP is received tax-free
• There is no capital gains tax to pay
• There are no tax liabilities when the property is sold
• In the event of the death of the SIPP holder (before the age of 75 and before they start accessing their pension), beneficiaries can receive the proceeds of the sale of the property free of inheritance tax.
• The costs of buying and managing a property in a SIPP need to be taken into account, as these can be quite high, and there are also legal and valuation fees to pay.

It should also be taken into consideration that if the business were to fold, the owner would not only lose their source of income, but the pension fund would also lose its tenant, leading to the property being offloaded as a SIPP investment.

Can I invest in residential property with a SIPP?

A SIPP cannot be used to invest directly in residential property, although investing in a commercial property with a residential element such as a caretaker or gardener’s flat may be permitted provided it is rented to an unconnected person.

Investors who earn more than £3,600 a year can contribute up to 100% of their ‘Relevant UK’ earnings into their SIPP in each tax year and receive tax relief at up to their top rate of tax.

However, there is a limit on the total payments that can be made each year (excluding transfer payments).

Previous pension allowances

Any payments that exceed this annual limit are subject to a penalty tax charge of 40%.

Those who are unemployed or have no taxable income can still contribute up to £3,600 per tax year to a pension and receive basic rate tax relief of 20%. This means that a person who wishes to put £3,600 into their pension scheme only has to contribute £2,880 as the rest is topped up by the government. Contributions can be made by a third party such as a parent, grandparent, civil partner or spouse.

Payments can be made into a SIPP until the age of 75 and holders can decide when they want to start and stop their payments, and whether they want to make regular contributions or lump sum payments. Contributions can also be made by employers.

A company can pay up to the annual limit into an employee’s pension even if they earn less than this subject to demonstrating that the company can afford the payment.

There are special rules regarding the availability of tax relief for high earners,

Lifetime Allowance

As well as an Annual Allowance, it is important to remember that there is a Lifetime Allowance on the total balance of funds in all pension plans held by an individual.

If the total value of a person’s pensions exceeds this allowance at retirement, they will be liable to a penalty tax charge on the excess. If a person is registered for primary or enhanced protection with HM Revenue & Customs before 6 April 2009 then they may have a higher personal allowance or the lifetime allowance may not apply.

Relevant UK earnings

The earnings which pension contributions are based on are known as Relevant UK earnings. For people who are employed, this is the salary they receive from their employer in a tax year including any bonuses, commission or benefits.

For those who are self-employed, Relevant UK earnings are the profit they make in a tax year from their trade, profession or vocation, or from patent rights.

SIPP holders can take an income from their pension between the ages of 55 (as of April 2010) and 74, provided they have enough funds in their pot.

Upon retirement, 25% can be taken as a tax free lump sum and the remainder used to provide an annual or monthly income, which is subject to income tax. This can be done by purchasing an annuity as a form of secured income from an insurance company, or drawn from the SIPP, the alternative is called income drawdown.

What is Income Drawdown?

Income drawdown, also known as an unsecured pension (USP) or pension fund withdrawal, is where the remainder of the pension fund (savings minus 25% withdrawn as tax free lump sum) is left invested and used to provide an income from the SIPP.

One of the major advantages of income drawdown is that it offers greater flexibility. Unlike an annuity where the income is set, investors can take a different amount of income each year, and also which investments the income is drawn from which can be on an annual, half yearly, quarterly or monthly basis. Those who choose income drawdown over an annuity are also offered a wider range of death benefits.

For example, in the event that the holder dies before the age of 75, the reminder of the pension fund can be passed to a nominated beneficiary (with a tax charge).

For example, a surviving spouse or dependant(s) can take a lump sum death benefit of the remaining cash in the pension fund (minus a 35% tax charge), or a surviving spouse or dependant(s) can continue the income drawdown and make regular withdrawals.

lternatively, an annuity can be purchased for the spouse or dependant using the remaining funds.

However, once a person reaches the age of 75 they must use the remaining value of their plan to purchase an annuity, transfer the pension fund into an Alternatively Secured Pension, or a combination of the two.

What is an Alternatively Secured Pension?

Alternatively Secured Pensions (ASPs) are a form of income drawdown for people aged 75 and over. With an ASP, the holder continues to invest their savings and takes an income from the fund, in a similar way as USP. But there are some different rules between the two:

The maximum amount that can be withdrawn as an income is around 90% of a single-life lifetime annuity and the minimum is 55%. These limits are reviewed every year.

In the event of the death of the ASP holder, any remaining invested fund value must firstly be used firstly to provide for any financial dependants’ pension – for example an alternatively secured pension for a spouse, civil partner or dependant over the age of 75, or an unsecured pension for someone under 75, or a pension annuity.

After this any remaining funds can be passed on to a pre-selected charity fee of tax. If no charity has been chosen the surplus can go towards the death benefits of other members, including family members.

Any remaining funds used for the benefit of a spouse, civil partner, or financial dependant, are free of inheritance tax (IHT).However, if on the subsequent death of the ASP holder there are still unused funds remaining, those funds will be taxed for IHT as if they had formed part of the original pensioner’s estate on death.

What happens to my SIPP when I die?

There are two things that can happen when a SIPP holder dies. If that person passes away before they are able to draw any benefits from their pension pot, then the money will be paid out as a tax-free lump sum to their chosen beneficiary.

If the holder has already drawn down some of the tax free cash and income from the SIPP then inheritance tax will be charged if applicable and the remaining funds will be paid to the beneficiary.

Deciding on whether a SIPP Pension is a more suitable option than other forms of personal pensions can be tricky. Savers are generally advised to consult with a suitably qualified pensions’ adviser to start with.

Pension advisers will analyse your circumstances and take into account their investment risk profile.

In short, SIPPS are generally more suitable for investors who:

• want flexibility and control of their pension fund
• wish to invest in a wider range of investment options
• wish to consolidate all retirement funds and investments under one pension wrapper
• want more flexibility on drawing out an income from their pension pot
• have specific investment ideas – plans that cannot be met through investing in an insurance company pension fund
• understand the potentially higher level of investment risk
  understand the charges that can potentially be higher than investing into an alternative such as a personal pension

A SIPP may also be a suitable choice for people who are self-employed or those who do not have access to a pension scheme through their current employer.

There are many companies in the UK offering SIPPS or pensions with a self invested pension option.

These include household names such as Halifax, Prudential, AXA and Standard Life, as well as a number of specialist SIPP providers. But remember the providers are in effect providing the regulated wrapper for you to select where you wish to invest your fund

Major UK SIPP providers

• AXA
• Aviva
• AJ Bell (Sippdeal
• Alliance Trust
• Atsipp
• Barclays
• Close Wealth Management
• Eden Group Plc
• Fidelity Funds Network
• Halifax
• Hargreaves Landsdown
• Hornbuckle Mitchell
• IPS Partnership
• James Hay
• Killik & Co
• Legal & General
• Liverpool Victoria
• Newcastle Building Society
• Origen
• Pilling & Co
• Principal Investment Management
• Prudential
• Sarasin Investment Management
• Scottish Equitable
• Skandia
• Smith & Williamson
• Standard Life
• Suffolk Life
• Sun Life
• Winterthur