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SIPPs

The basics

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

Then take a look at 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 we may all yearn for a de-luxe car or pension, they may not necessarily suit our needs, or more importantly, our 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 around since the early 1989, but until recently were only economic for those with very large pension funds because they were so expensive. Increasing competition in recent years has brought charges down and made them more accessible.

Changes in the pension rules in April 2006 (known as the A-Day changes) allowing increased contributions have also made it easier to set up a Sipp. In addition, more people are now turning to SIPPs when they reach retirement, if they want to take an income direct from their pension fund, in the form of a so-called ‘unsecured pension,’ which gives them greater control over how and when they take income from their fund.

How do SIPPs work?

SIPPs are simply an upmarket version of a 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 how much you invest, the growth of your investments, how much is deducted in charges and annuity rates (if you decide to convert your fund into an annuity at age 75).

As with other types of pensions, you will receive income tax relief on your contributions and the investments in your SIPP will grow virtually tax free. You can take a tax free lump sum, plus an income from your SIPP between the ages of 50 and 75, although from 2010 the minimum age at which you can take retirement benefits increases to 55.

How much can I contribute to a SIPP?

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 or be investing lump sums of several thousand pounds a year.

Since April 2006, the maximum amount that you can contribute to your pension each year and qualify for tax relief is the equivalent of 100 per cent of your taxable earnings (called net relevant earnings), subject to an annual limit of £215,000 and an overall lifetime limit for your pension pot of £1.5m. (These are the limits for the tax year 2006-07 and 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 a pension and receive basic rate tax relief.

Many people transfer previous pension policies into a SIPP so they can consolidate their retirement savings in one place and thereby benefit from easier administration and possibly most cost effective charges.

Who can take out a SIPP?

Anyone can take out a SIPP nowadays. Even if you are already contributing to another pension, such as an occupational (company) pension scheme, you can also put money into a SIPP at the same time providing you don’t exceed the maximum pension contribution limits.

But it is important to be sure that you are really going to make use of the investment freedom a SIPP offers and that it makes financial sense for you to do so as some SIPPs are more expensive than other types of pensions.

What investments can be included in a SIPP?

Here is a list of the main investments permitted in a SIPP:

  • 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

How can I invest in property via a SIPP?

One of the attractions of SIPPs is that they can be used to invest and develop commercial property, such as offices, industrial units or shops. Your pension fund does not even have to be large enough to buy a property outright as you can borrow up to 50 per cent of the fund’s net value.

In other words, if it is worth £150,000, you could borrow another £75,000 to buy a property for around £225,000. The rent from the property can be used to cover the mortgage repayments. If there is no mortgage, the rent will remain in your SIPP fund and can be used for other investments.

However, it is important to bear in mind that the costs of buying and managing a property in a SIPP can be fairly hefty. SIPP providers typically quote fees of between £500 and £750 for property purchase and there will also be legal and valuation fees to pay. In addition, ongoing annual management charges will be payable.

It is not possible to invest directly in residential property via a SIPP, although a commercial property with a residential element such as a caretaker’s flat may be permitted.

An alternative for those who want to invest in residential property may be to do so via 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 as this will increase the risk and the amount you may have to pay for the maintenance of the properties as well as the costs to be covered when there are ‘void’ periods between lettings. Most importantly of all, you should find out your options for selling your investment.

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. As the trustee, your SIPP provider has the final say on what can go into your pension.

By far the greatest demand for property investment within a SIPP 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 can have several tax advantages. The rent paid into your SIPP is free of tax because it is a tax deductible expense. There will be no capital gains tax to pay on the property when it is sold within the pension fund and if you die before age 75 and before you start drawing your pension, your beneficiaries can receive the proceeds of the sale of the property free of inheritance tax.

What are the charges on SIPPs

SIPP charges vary considerably from provider to provider and can be expensive, but here are the main charges* you may be asked to pay:

  • 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: there may be a charge if you are moving funds from other pensions into your SIPP.
  • Annual fees: these cover annual administration costs, which can range from nil to £1,000 per annum, but are more usually in the range £400 to £600.
  • Dealing charges: The cost of buying and selling investments (other than property) within a SIPP varies from nil to around £35.
  • Property purchase: The pension trustees will usually charge between £450 and £650 for their services if you buy a commercial property. This will be in addition to the usual legal and surveyors fees you will have to pay.
  • Exit charges: there may be charges if you decide to transfer your SIPP elsewhere.
  • Additional costs: If you do not have the time or the expertise to manage the investments in your SIPP, you may want an investment adviser to help you. This service will normally cost you the equivalent of between 0.5 per cent and 1 per cent per annum of the value of your pension fund.

How do I choose the right SIPP for me?

The first step is to decide what kind of investments you want in your pension. There is no point choosing a SIPP which gives you access to every type of investment, if you are not going to buy them, because full SIPPs are often the most expensive.

If you are happy to invest your pension in investment funds and stocks and shares, 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 quite comprehensive SIPPs and you may like the idea of dealing with a familiar name such as Legal & General and Scottish Widows but they will often quite require you to invest a proportion of your SIPP in their insurance funds before you can self-invest.

SIPP specialists tend to offer the widest range of investments. Those companies which offer the best value full SIPPs, according to the research organisation Defaqto, include IPM Pension Trustees, ODL Securities, Wensley Mackay, European Pensions Management and Skandia.

Who are SIPPs suitable for?

Although SIPPs can be taken out with more modest investments nowadays, it is generally recommeded 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 your savings is generally 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.

Those who opt for SIPPs and invest their pension funds in shares and specialist investment funds must also be aware of the greater risk they are taking than if they were investing in a managed pension fund.

Where investors put a large proportion of their pension into a commercial property, they need to consider the dangers of having too many eggs in one basket. A diversified portfolio of investments can help reduce risk.

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

If you contact your chosen SIPP provider and give them details of your previous pensions, they will arrange for the transfer of your funds into your SIPP. However, it is vital to take professional advice first.

Even though you may not be impressed with your previous pensions, they may include such things as guaranteed annuity rates which could give you a much higher pension than would be available if you were to switch, or there may be a large penalty for transferring.

If you are considering switching from an occupational scheme, you may also be at risk giving up some valuable benefits such as spouse’s and dependants’ pensions as well as ill health and early retirement benefits.

If part of your pension has been built up from National Insurance rebates as a result of being opted out of the State Earnings Related Pension Scheme (SERPs) or the State Second Pension (S2P), these funds cannot currently be transferred into a SIPP but must be invested into an insurance plan.

What are the alternatives to SIPPs?

If your main concern is to be able to spread your pension savings among a variety of different investment groups rather than being tied to one set of funds offered by your pension company, a cheaper solution than a SIPP could be an ordinary personal pension where you are offered a wide choice of external managers. These are offered by companies such as AXA, Scottish Widows and Standard Life.