Forward Diary

How to Invest in SIPPS

SIPPs have revolutionised saving and are a great way to take control of your pension planning. Outside company schemes, pensions were long the province of the life insurance companies. However, in the two decades since the launch of Self-Invested Personal Pensions, or SIPPs, we have seen the arrival of a number of competing providers. In the personal pension arena, SIPPs are the main area of interest for active investors as they give you control over the underlying portfolio. Holders can deal and switch within a wide range of investments allowed by the tax man – although this must also be
within the list of those permitted
by each scheme’s administrator. SIPPs had their origin in 1989
when the then-Chancellor, Nigel Lawson, put forward proposals in
his Budget speech for a new type of pension scheme in which members
could have control over their investments. This helped crystallise a movement among savings industry professionals who had wanted to find a way to help more people take charge of their pensions savings. Around half a million savers have now taken up a SIPP and the number of providers has grown to more than 100. SIPPs carry the same tax benefits as other pension plans. All contributions are paid net of basic rate tax, with the rebate paid directly into the pension plan. Investments within the SIPP do not attract capital gains or income tax, except for dividend tax credit which cannot be reclaimed and some overseas withholding taxes. Funds may be withdrawn from the SIPP from the age of 55. Holders can take 25% as a lump sum free from tax, with the rest being used to fund a taxable retirement income (see the section on options at retirement, chapter 2). Costs vary widely, not only from provider to provider but from plan to plan, depending on how tailored it is, the level of service required and the types of investment permitted. Typically there will be a flat annual administration fee, an establishment charge and dealing charges (usually lower for online rather than telephone transactions).  However, these are by no means universal. The investments chosen for the portfolio may have their own initial and annual charges on top of the provider’s dealing fees, but on the other hand many providers offer discounted initial charges on a range of unit trusts and OEICSs (see more on charges in Typical SIPP Costs box later in this chapter). Some interest should be received by holders on cash in the plan, albeit modest. Plans which allow property purchases will have a separate set of fees for administration of these assets and for transactions. The size of pot you need to make running a SIPP worthwhile – as opposed to a stakeholder pension, say – is a difficult question. SIPPs by their nature as wrap-based products have some additional costs, but these will be much greater for a full-blown bespoke plan than for a low- cost online product. Some advisors have suggested a £50,000 pot as the minimum you will need to run a portfolio
 and that below this level
 stakeholder or personal
 pension contracts offer a
reasonable fund choice at
 a low cost. The cheapest 
place to build up your savings is generally in a stake-holder pension, where 
charges are capped at 1.5% per annum for the first 10 years and 1% per annum after that. However, investment in stakeholder plans is usually limited to a narrow range of funds, while personal pensions, although offering a wider range, still do not provide anything like the flexibility of a SIPP. Holding a SIPP does not rule out investing in other forms of pension plan at the same time – you can take out a SIPP and run it alongside occupational and personal schemes, subject to the rules on maximum contributions as outlined earlier in this guide.   How the product works A SIPP is a type of personal pension plan that allows the holder control over the underlying investments – with or without the help of a financial adviser. Holders can manage their own port- folio by dealing and switching within the list of allowable investments, although this must also be within the range of investments permitted by the scheme’s administrator. Equally, one could employ an authorised investment manager to make those decisions, though for a good many SIPP holders this would rather defeat the point of having one. A SIPP may be started by an individual or an employer. The provider must be approved by HMRC in order for the plan to qualify for tax relief. Approved providers include brokers, pension consultants, IFAs, insurance companies and fund man- agers, as well as SIPP specialists. Each plan must involve a scheme provider and an administrator, though these may come from within the same organisation. The scheme administrator runs the SIPP on a day-to- day basis, which includes collecting and recording contributions and dealing with HMRC, for example when claiming tax relief on contributions. The assets are owned by the SIPP trustee (in practice usually the provider) and all sales and purchases are made in the trustee’s name. In this respect, a SIPP differs from an ISA in that it is an investing entity in its own right, rather than simply being an account owned by the customer.   Contribution and age
 The maximum contributions
you may wish to make – and
which are tax-efficient – are
tied in inextricably with the tax regime governing pensions. There is no age minimum for contributing to a SIPP but you can only claim tax relief on contributions if you are no older than 75.   Contributing for others You are allowed to take out a SIPP for someone else, such as a child or partner. They will receive tax relief on the contributions you make, based on their earnings. If they do not pay tax, the maximum you can contribute for them a year is £2,880, which will be boosted to £3,600 by the government. Or to turn it round the other way, you can con- tribute up to £3,600 to a pension and with basic rate tax relief of 20%, the cost is only £2,880. This does not affect the amount you can contribute to your own pension plans as it is based on the SIPP holder’s own status. By the same token, though, any higher rate relief due will be
 based on their earnings and can be claimed by them, rather than yourself. An employer can make contributions into your SIPP.   Risks and rewards Obviously, you will want to build as large a pot of money as possible inside your SIPP, as with any pension plan, to fund your retirement. How much retirement income the plan is eventually capable of generating will depend on how much you invest, the growth of your investments, how much is deducted in charges and on the annuity rates that apply if and when you decide to convert the fund into an annuity.
 Many people underestimate how large a pension fund they will need to provide the retirement income they want. When it eventually dawns on them they may face a shortfall, the tendency may be to panic and switch to comparatively adventurous investments such as emerging markets funds. However, the greater the potential reward, the greater the risk of losing money. A standard managed pension fund may look unexciting but the spread of risk means there is less chance of your pension pot actually shrinking. And remember, the closer you are to needing to draw a retirement income, the less time the fund has to recover if the financial markets slide. Commercial property may look tempting if you can afford it, but it is a ‘lumpy’ proposition, requiring a large investment for each transaction. Moreover, it is comparatively illiquid: you cannot sell property as easily as a fund or a unit trust, where there is a ready market waiting. You could easily find yourself with too many eggs in one basket. Conventional wisdom suggests that you should move your investment exposure away from the share markets and progressively towards fixed interest investments – primarily gilts (UK government bonds) – over the last decade or so before your expected retirement date. However, individual cases vary and not everyone will need to convert to an annuity, or for that matter draw down income, at normal retirement age. For them it might make sense to leave the fund invested in equities for longer. Transferring pensions One of the key attractions of a SIPP is the ability to consolidate pension plans. You can transfer benefits from any UK-registered pension scheme and can make a transfer even if you have started to draw down income. Transfers can be made from another SIPP, as long as they involve investments that are acceptable within the plan to which you are transferring. You may also transfer out of the SIPP into another UK registered or qualifying overseas pension scheme. It’s simple enough to switch to a SIPP. All you need to do is contact the SIPP providers and give them details of your existing pensions. They will then arrange for the transfer of funds. However, the grass may not be as green on the other side as you imagine. You may also find providers are wary of accepting a transfer from a final salary (or defined benefit) scheme and request or even insist that you seek proper financial advice first. Ever since thousands of company pension scheme members were persuaded to switch into less attractive personal pensions back in the Thatcher era, leading to the ‘pensions mis-selling’ scandal, advisers and pension providers have been cautious about advising people to leave their existing plans. Questions which may need addressing include such issues as whether the existing pension offers benefits such as guaranteed annuity rates, which could generate a higher level of pension, or whether you may face a large penalty for transferring out. Occupational schemes may include attractions such as spouse’s and dependents’ pensions, or ill heath and early retirement benefits. Many company schemes are not as good as they once were, with the former gold-plated final salary scheme being closed and replaced by defined contribution schemes, where the company contribution may be less and the value of the fund is at the mercy of the markets. However, that doesn’t necessarily mean you should pull out of them – certainly not without having a serious discussion with an independent financial adviser. One of the main reasons for choosing to switch existing pensions into a SIPP is to consolidate your retirement savings into one place, making them easier to manage and possibly saving on costs. Some people choose to switch existing pensions into a SIPP shortly before retirement, in order to take an ‘unsecured pension’ – a form of income drawdown, which gives you greater control over how and when you take income from the pension fund. Again, however, before you take any firm action talk to a professional adviser and ensure that you are not throwing away benefits which would be impossible to replicate in a SIPP. It is sometimes possible to be dazzled by the bells and whistles a product offers but make sure you are genuinely going to make use of them before you commit yourself: like most things in life, there is often a price to pay for the extras. Types of pension you may generally be able to transfer to a SIPP include: Personal pension plans Stakeholder pension plans Retirement annuity contracts Other SIPPs Free Standing Additional Voluntary 
Contribution Plans (FSAVCs) Executive Pension Plan (EPPs) Most paid up occupational money purchase 
(defined contribution) plans 
   What happens if you die? 
If a SIPP holder dies before drawing any benefits from the plan up to age 75, the money invested will be paid out as an inheritance tax-free lump sum to the holder’s chosen elected beneficiary. In the case of a holder who has already drawn benefits from the SIPP, tax will be charged and the remaining portion paid to beneficiaries. The tax on lump sum death pay-outs from drawdown funds where the investor is under 75 is set to increase from 35% to 55% from April. Over-75s investing in an ASP will see a cut to 55% from 82%. Existing holdings Investments you already own can be used to con- tribute to a SIPP via a ‘bed and SIPP’ process. This involves the provider selling an investment holding and buying it back again straight away. Ideally the spread (difference between buying and selling prices), dealing costs and time you are out of the market should be kept to a minimum. The transaction is classified as a pension contribution so should be eligible for tax relief. There is also the option of making contributions of assets that are currently owned by the individual (or an employer) into the SIPP, rather than making a cash payment. This is known as an ‘inspecie’ transfer. The asset must be a permitted investment under the SIPP terms. An in-specie transfer allows you to arrange transfers into your SIPP without having to encash the existing investments. It also avoids dealing expenses and the risk of being temporarily out of the market. The procedure may be quite technical, though, and will require professional assistance to undertake. Protected rights Contracting out of the State Second Pension (S2P), or SERPS as it was previously known, has been available for around 20 years, with the rebate being paid into a personal pension plan. This investment is known as ‘protected rights’. In October 2008, it became possible to transfer the money into a SIPP. It has been a short window of opportunity for SIPP savers, though – as from 2012 protected rights will be abolished and people will no longer be able to contract out of S2P. Until then, pension providers must continue to keep a separate track of protected rights within individual funds. Meanwhile providers will only accept a transfer of existing protected rights funds. When you transfer your protected rights into a SIPP, if applicable you will automatically be contracted back into the S2P as the provider cannot accept future National Insurance rebate contributions. To find out more go to AJ Bell Youinvest This ‘How to’ guide is produced by Shares Magazine and is only for general information and use, and is not intended to address particular requirements. The value of investments and the income derived from them can go down as well as up. Past performance is not necessarily a guide to future performance. You should get professional financial advice before making any investment decisions.