What are self-invested personal pensions?

26 May 2015 ( 27 February 2020 )

If you’re a confident investor you can create your own bespoke personal pension with a SIPP, but it’s not without risks.

Self-invested personal pensions (SIPPs) do what they say on the tin. They are, of course, personal pensions. And you decide where the money is invested.

That makes them very different from the normal sort of pension you might buy from a major pension provider, which will decide where your money is invested and manage it for you.

SIPPs give you more choice

You may have the choice between various types of fund and the pension provider will ask you about what it likes to call your risk profile. But once that is sorted it makes the major decisions about which funds your money is in.

Not so the SIPP. With a SIPP you can choose where your money is. The following are all options:

* Unit trusts are a common sort of investment and are usually mainly in shares. Some are biased towards foreign shares or smaller firms; others track one of the indexes on the London Stock Exchange, following the market up and down. If you invest in a unit trust, then go for one with the lowest costs – the one thing you can control – and do not even think that past performance says anything about future performance.

* Exchange Traded Funds or ETFs are also index trackers, and usually cheaper. You can buy shares directly in companies – though that is a risky strategy.

* Gilts are UK government bonds whose value can go up and down but which have a degree of safety.

* Corporate bonds are loans to companies which can offer a good yield but come with the risk of default.

* You can even put your money in cash – and pure cash in a bank or building society account is the cheapest way to do that. Some funds called ‘cash’ are expensive, with charges often outstripping the very poor returns.

Of course, you can buy a mixture of all these things or choose something riskier still. Beware of advisers who may not be regulated offering you big returns on a SIPP invested in things you have never heard of. You could lose the lot.

Advised SIPPs

You are free to do what you want, but you are also responsible if it goes wrong, so you need the confidence and the knowledge to make the right decisions.

There is a halfway house. You can invest in a SIPP but also get advice from a regulated financial adviser about where to invest the money. In that way you have a tailor-made pension.

Advised SIPPs will be more expensive than the ones where you make all the decisions independently – usually called an ‘execution only’ SIPP service, which just carries out (or executes) your wishes and takes no responsibility for them being sensible or not.

You will normally manage your SIPP online through what is called a ‘platform’, which is a bit like a bank account. The quality and the cost of platforms varies. Some providers will integrate the SIPP and the platform and sell them as a bundle. Check that you can easily see where your money is invested and, if you want to, move it easily into other investments.

What are the costs related to SIPPs?

Most providers make no charge for setting up a SIPP (though some do), but once you have one open then there are five charges you may face. First, there will usually be an annual administration charge, which could be £100 a year or a percentage relating to your level of investment, such as 0.40%.

Then, if you want to transfer money in from another pension, you will usually be charged for doing that – either a fixed fee of up to £200 or a charge for the time it takes, which may cost more.

Third, there will be annual charges on the funds under management – anything from 0.2% to 1% of your money. That is a percentage of the whole value of your fund. If you have a £100,000 fund, a charge of 0.5% is £500 a year; if you have £250,000, then it is £1,250.

Fourth, if you buy or sell shares – or buy or sell units in funds – you will be charged in the region of £10 per trade, but possibly up to £20.

Finally, if you want to move to another provider you will be charged to transfer out, usually about the same as the annual administration charge.

Other costs and charges

If you want financial advice, then you will pay for that in addition either at an hourly rate or a percentage of your funds. Some advisers may charge an additional percentage of your funds every year to keep an eye on your money. Make sure you know what your adviser does for the fees charged.

If you are at least 55 and want to start drawing your pension, some providers will let you move from a SIPP to a drawdown product. Others may restrict what you can do or insist you transfer to another scheme to start taking money out. When you take money out of your SIPP, a quarter of it will be tax-free, but any more will be added to your income and taxed.

Tax subsidies

As with all pensions, the money you put into a SIPP comes with a big subsidy from other taxpayers. Every £100 you put in out of your taxed income is boosted by £20 from the Treasury, so £120 ends up in your fund – the £20 is the tax you paid at basic rate on £120 of income.

Higher or additional-rate taxpayers can benefit further by claiming back an additional 20% or 25% respectively. The maximum amount that can be contributed out of your income is £40,000 a year.

If you have a pension at work, the contributions paid into that will count towards that limit in a complex way and will reduce the amount you can also put into a SIPP. The £40,000 annual allowance is cut to £10,000 if you take more than the tax-free lump sum out of your pension. If you exceed the limit you will face a hefty tax charge, so make sure you take advice from an independent financial adviser with specialist pension qualifications.

What is the Lifetime Allowance?

There is also an overall limit to the amount you can save in a SIPP called a Lifetime Allowance. This stands at £1.005 million, and you will be taxed on any pension savings you make beyond this figure. That may sound a lot, but a pension from your job of, say, £50,000 a year would be valued at £1 million and use up virtually all the allowance. And if you have £1 million in a pension pot, you could buy an index-linked pension of around £30,000 a year at the age of 65.

SIPPs and inheritance tax

Any money left in a SIPP when you die is free of inheritance tax. You nominate who will benefit from it. If you are under 75 when you die, they receive it tax-free – either as a pension or a lump-sum.

You will not be subject to taxation at the usual rate of 45% for assets valued above £325,000.

If you die at 75 or over, it can remain tax-free in a pension fund but if the beneficiaries draw money out, that is added to their income and taxed accordingly.

The opinions expressed are those of the author and are not held by Saga unless specifically stated.

The material is for general information only and does not constitute investment, tax, legal, medical or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.