What is…? A new series to help you understand the basics of the different types of investment.
A Self-Invested Personal Pension (SIPP) is a wrapper that holds your pension investments. As with other pensions, it is one of the most tax-efficient ways of saving for your retirement.
Unlike traditional pensions where investment choice can be limited and not very transparent, a SIPP gives you the freedom to invest almost anywhere you like. This opens up a world of opportunities, but also means you must be confident (and preferably experienced) with choosing and managing your own investments over potentially a long period of time.
What are the benefits of a SIPP?
1. Tax benefits
SIPPs offer the same generous tax benefits as other pensions.
- Tax-free investing. Your money will grow free from capital gains and income tax.
- Government tax relief. The money you invest in your SIPP will be topped up by 20 per cent by the taxman. Higher and additional rate taxpayers can claim back 40 per cent and 45 per cent respectively.
- Free from inheritance tax. You can pass on your pension tax efficiently, and in some cases completely tax-free.
Remember that pension and tax rules can change and benefits depend on your circumstances. In Scotland, tax bands are different and different benefits apply.
What sets SIPPs apart from other personal pensions is the flexibility it gives you to invest in a wider range of assets. These include unit trusts, investment trusts, government securities, insurance company funds, deposit accounts with banks and building societies, gilts and bonds, commercial property (such as offices or factory premises), and individual listed stocks and shares.
You choose exactly where your money is invested and how much of your pot you put into each investment. It is up to you to decide the strategy you want to use for your SIPP investments, and for buying and selling assets in line with that strategy.
3. Potentially higher returns
In theory, a SIPP has the potential for higher returns than a personal pension due to the more active management involved and wider range of higher risk investments available. However, while higher risk can bring higher reward, there is also the chance of more significant losses.
4. Choose investments in line with your values
With a SIPP, the investments are up to you. This means you can choose from a wide variety of investment options deemed to be ethical or sustainable. You will need to look carefully at each investment and work out whether it aligns with your values. Many financial advisers specialise in ethical investments, and most should be able to advise you on how to make your pension greener or more socially responsible.
How much can I put into a SIPP and when can I take it out?
You can contribute 100 per cent of your annual income (up to the maximum annual allowance of £40,000) to your SIPP each tax year.
A SIPP allows you to withdraw up to 25 per cent of your pension as a lump sum, free of tax, when you reach age 55. As with other personal pensions, there are several options for receiving SIPP payouts after this such as drawing a regular income, buying an annuity or taking out regular lump sums.
What are the drawbacks of a SIPP?
1. Higher charges
A SIPP could work out more expensive if you have a smaller pension pot. While the cost of a personal pension is usually percentage-based, a SIPP typically has a fixed annual fee.
There will also most likely be additional charges for activities such as fund switches, additional valuations, contributions and withdrawals. These will vary between providers so it’s definitely worth checking before you take the plunge.
Lower cost SIPPs are on offer with some providers, but they will come with a more limited choice of investment options.
2. Takes time and experience
The flexibility and freedom a SIPP offers is a benefit for some, but could be a huge downside for someone who is not experienced in investing and doesn’t have the time or motivation to actively manage their pension. Many people who have a SIPP will need a financial advisor to help them manage it, which is an added cost that needs to be considered.
Would a SIPP suit me?
SIPPs are most suited to people who are comfortable with making their own investment decisions (or can pay a financial advisor to do so) and who want a wider range of investments in their pension.
Because of the fixed annual charge and additional fees, SIPPs are generally most cost-effective for people with larger pension pots (this is at least £100,000, preferably more) or who plan to make significant pension contributions.
Risk warning: Please remember that the value of investments, and any income from them, can go down as well as up and you may not get back your original investment.