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Sipps 

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Last updated 8/28/2008

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Guide to Sipps

Fancy a Rolls Royce pension, rather than the pension equivalent of a Ford Mondeo?

Then take a look at Self Invested Personal Pensions (Sipps) - the luxury model of the pensions market, which comes with all the bells and whistles you could dream of, compared to personal pensions (think Ford Mondeo) or stakeholder pensions (think Smart car).

But remember that luxury comes at a price and that while you may hanker after a de-luxe pension, this may not necessarily be appropriate for your needs, or more importantly, your pocket.

Self invested personal pensions (Sipps) are personal pensions which allow you to choose where you want your retirement savings to be invested, instead of leaving a pension company to make the decisions.

You can hold a wide variety of investments in a Sipp, from investment funds and shares to commercial property and futures and options.

Sipps have been in existence since 1989, but until around 2001, they were only economic for those with very large pension funds because they were relatively expensive. But Increasing competition in recent years has driven down chargesa nd made Sipps much more accessible to ordinary investors.

Changes in the pension rules in April 2006 (known as the A-Day changes) allowing investors to take their pensions in a more flexible way have also increased the attraction of Sipps.

Some people choose to switch existing pensions into a Sipp shortly before retirement, in order to take an ‘unsecured pension.’ The latter is simply a form of income drawdown which gives you greater control over how and when you take income from your pension fund.

How do SIPPs work?

Sipps are simply an upmarket version of the personal pension plan. The only real difference is the wider range of investment options they offer.

The amount of pension you will get at retirement from a Sipp will depend on the size of your fund at retirement, which will be dictated by the growth of your investments net of charges. The other factor will be annuity rates at the time you convert your fund into an annuity.

Alternatively, If you chose to take an unsecured pension (more on this later) you can choose how much income you want to withdraw each year (if any) between certain limits laid down by the taxman.

As with all types of pensions, you receive income tax relief on your contributions and the investments in your Sipp grow largely tax free.

You can take a tax free lump sum of up to 25 per cent of the fund, plus an income from your Sipp between the ages of 50 and 75. But from 2010, the minimum age at which you can take a personal pension benefits increases to age 55.

How do I get started?

Most Sipp providers do not specify a minimum investment, but it is generally recommended that you should have an existing pension fund of around £50,000 to transfer in or  be able to contribute several thousand pounds a year, although some providers will let you start with a sum as small as £5,000.

Since April 2006, the maximum amount that you can contribute to your pension each year and qualify for tax relief is 100 per cent of your taxable earnings (known as your ‘net relevant earnings’).

This is subject to an annual limit of £235,000 and an overall lifetime limit for your pension pot of £1.65m. (These are the limits for the tax year 2008-09 which will be increased in future tax years).

Even if you are not working (and are therefore a non taxpayer), you can contribute up to £3,600 per tax year to stakeholder pension at a net cost to you of just £2,880 (ie net of 20 per cent basic rate tax relief)..

Consolidating pensions into a Sipp

Some people transfer existing pension policies into their Sipps so that they can consolidate their retirement savings in one place and thereby benefit from easier administration and possibly cost savings,

While this can be a good idea in certain circumstances, you need to check that by doing so you will not be penalised with surrender penalties or forfeit any valuable benefits which you cannot replicate within a Sipp.

This could apply if you are transferring a with profits fund, or any fund which carries a high guaranteed annuity rate, or if you are transferring valuable benefits from a final salary occupational scheme which may have generous ill health, early retirement and children’s pensions. These benefits would be impossible to match via a Sipp.

This is why you should take professional independent financial advice before moving any pension funds into a Sipp.

Who can take out a SIPP?

To take out a Sipp, you must be under age 75 and be resident in the UK, or a Crown servant, or the spouse or registered civil partner of a Crown servant.

Even if you are already contributing to another pension scheme, such as a company pension scheme, you can also put money into a Sipp at the same time, providing that you don’t exceed the annual contribution limit.

If you choose a Sipp, rather than a personal pension or stakeholder pension because of the wider range of investments they allow, be sure that you do use these facilities in practice. Otherwise you could be paying higher costs for nothing.

If you have a modest size pension, and don’t want to invest in anything other than standard investment funds, you would normally be better off with a stakeholder pension, which is likely to be cheaper.

What investments can be placed within a SIPP?

Here is a list of the main investments permitted in within Sipps:

  • Deposit accounts (in any currency providing they are with a UK deposit taker)
  • Government securities and other fixed interest stocks
  • Unit trusts
  • Open ended investment companies (oeics)
  • Investment trusts
  • Insurance funds
  • 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
  • Commercial property
  • Ground rents in respect of commercial property
  • Traded endowment policies
  • Permanent Interest Bearing Shares (PIBS)
  • Warrants
  • Futures and Options
  • private equity
  • hedge funds

How can I invest in property via a SIPP?

One of the principal  attractions of Sipps is that they can be used to invest in and develop commercial property, such as offices, industrial units, or shops. Your can borrow up to 50 per cent of the value of your pension fund’s net value, via a mortgage.

So if your fund’s net value is £150,000, you could borrow £75,000 to buy a property for a maximum of £225,000. The rent from the property which is paid gross into your Sipp fund can be used to cover the mortgage repayments. If there is no mortgage, the rent will still be paid gross into your Sipp fund, and invested as you wish.

However, it is important to bear in mind that the costs of buying and managing a property in a Sipp can be hefty. Sipp providers typically quote fees of between £500 and £750 for property purchase and there will be all the normal costs associated with property purchase, such as legal and valuation fees. In addition, ongoing annual management charges will be payable.

Residential property

It is not possible to invest directly in standard residential property via a Sipp, although a commercial property with a residential element such as a caretaker’s flat attached to a nursing home, or a flat above a shop may be permitted.

For those who want to invest in residential property, this can only be done via a property syndicate or collective fund. These schemes are allowed within Sipps, providing they have at least 10 investors and own at least three different properties worth a minimum of £1m in total.

Not all Sipp providers will currently accept these schemes and before investing, you should look carefully at how they work. Find out the level of borrowing which the scheme will entail as this will increase the risk.

Costs

Also ask about maintenance and service charges, and factor in the cost of ‘voids’  - periods when the property may be empty between tenancies. Most importantly of all, you should think the implications  if you, or another member wants to sell their share in the syndicate.

Other property-related schemes which may be available within a Sipp are buy-to-let hotel room investments in the UK. It has been suggested that similar schemes abroad including ski chalets may also be suitable, but some leading SIPP providers still feel this is a grey area. Check with your Sipp provider first.

Buying your own business premises

By far the greatest demand for property investment is from small business people who want to buy their own business premises. Changes to the pension rules in April 2006 mean such purchases are now possible, even if the property is already owned by the investor or someone connected to them.

Buying your own business premises within a Sipp and renting them back to yourself  carries several tax advantages. The rent paid into your Sipp is free of tax.

There is  no capital gains tax to pay on the sale of the property (assuming it is still in your pension fund at the time of sale).

Finally if you die before age 75 and before you start drawing your pension, your beneficiaries can receive the proceeds of your Sipp free of inheritance tax.

Charges

Sipp charges vary considerably from provider to provider and can be expensive, but the main charges are as follows:

  • Set up fees: initial charges for setting up a Sipp range from nil to £750, but are typically between around £200 and £400.
  • Transfer-in charges: for moving funds from other pensions into your Sipp (variable but typically £50)..
  • Annual fees: for administration costs can range from nil to £1,000 a year, but are usually in the range £400-£600.
  • Dealing charges: the cost of buying and selling investments such as unit trusts, Oeics, shares.
  • Property purchase: The pension trustees will usually charge between £450 and £650. This will be in addition to the usual mortgage arrangement fees, legal and surveyor’s fees
  • Exit charges: there may be charges if you decide to transfer your Sipp elsewhere.
  • Discretionary fund management charges:  if you want a professional investment manager to manage your investments, this could cost between 0.5 - 1 per cent per annum of the value of your pension fund.
  • IFA fees: If you set up your Sipp on the advice of an IFA, he or she will probably be taking trail commission from the annual management charges levied on the investments funds you hold in the Sipp. This should pay for ongoing reviews of your investments. Alternatively, you can ask to pay via fees, but if you do this, you should ask for a discount on fund charges.

How do I choose the right Sipp for me?

The first step is to decide what kind of investments you are likely to purchase within your Sipp. There is no point choosing a Sipp which gives you access to every type of permitted investment, if you have no intention of using them, as you will be paying unnecessarily high charges.

If you are happy to invest your pension in investment funds and direct shares only, you will probably find a low cost Sipp will meet your needs. These are offered by Hargreaves Lansdown, Alliance Trust Savings, sippdeal.co.uk (provided by AJ Bell), and Killik & Co. James Hay also offers a low cost plan called esipp.

Some insurance companies offer ‘hybrid’ Sipps, whereby you are required to invest a proportion of your Sipp in the insurer;s own funds before you can invest elsewhere.

Sipp specialists tend to offer ‘full Sipps’ giving you access to the widest range of investments. Full Sipp providers include IPM Pension Trustees, ODL Securities, Wensley Mackay, European Pensions Management, Pointon York and SuffolK Life.

Who are Sipps suitable for?

Although Sipps can be started with a modest outlay, it is generally recommended that you should already have a pension fund in the region of £50,000 in order to make a Sipp cost effective.

The cheapest place to build up pension savings from scratch is in a stakeholder pension where charges are capped at 1.5per cent per annum for the first 10 years and 1 per cent per annum thereafter.

Some of the investments permitted within Sipps are high risk (such as hedge funds and private equity) and commercial property is a long term illiquid investment. So these are largely suited to professional investors and individuals who have the time and expertise to manage their own investments.

How do I move my existing pension/s into a SIPP

Give your Sipp provider the details of your previous pensions, and they will arrange for the transfer of the funds to your Sipp. However, it is vital to take professional advice first.

From October 2008, it will be possible to place rebate only personal pensions within Sipps and invest this money as you wish. Until then, such funds must be invested in cash or gilts.

What are the alternatives to SIPPs?

If your main concern is to be able to spread your pension savings across a wide variety of different investment houses, rather than being tied to the in-house funds offered by your pension company, a cheaper solution than a Sipp would be a stakeholder pension ( or possibly  a personal pension, but these are usually more expensive than stakeholder pensions).

Many stakeholders now offer a wide choice of funds, including some from external managers. Many insurance companies offer stakeholder pensions including  Legal & General, Scottish Widows and Standard Life.

From 2012, there will be another low cost form of personal pension called a 'personal account.' This will be part of a Government-led initiative to encourage  workers who are not eligible to join a good company pension scheme to contribute to a low cost personal pension.

 

 

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