An investor’s guide to SIPPs (P1)

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In recent years it’s become clear that the developed world faces a retirement crisis.

Private pensions are becoming far less generous (most companies have ceased to offer final salary structures) and we’ve seen cutbacks in public spending thanks to austerity measures in response to the financial crisis of 2008. To make things worse, savers have been caught in the crossfire of low interest rates designed to breathe life into the economy.

But it’s not all doom and gloom. “Pension Freedom Reforms” introduced by the UK government in April 2015 have made it easier for people to take control of their pensions. Self-Invested Pension Plans (SIPPs) are a key part of this movement, one which presents huge opportunities for those with the initiative to take their long-term financial security into their own hands. 

In this two-part blog series, we take a closer look at SIPPs. So let’s get into the basics of what SIPPs are, what they enable you to do, and most importantly, why you might benefit from having one.

What exactly is a SIPP?

SIPP stands for Self-Invested Personal Pension. They differ from traditional employer administered pension schemes, which give holders fewer options as to how their retirement funds are managed.

SIPPs are long-term, tax efficient investments designed to help fund your retirement. They can be thought of as “DIY” pensions – you choose which investments to make and remain in control throughout the process, managing your savings via an online platform.

This approach has two advantages over the traditional approach to pensions. Firstly, it gives people visibility over their retirement funds and how they are performing. And secondly, for those who are financially savvy enough to manage a portion of their own pension, it provides much more flexibility to proactively diversify across different asset classes at short-notice.

What can I invest in via a SIPP?

Bonds, stocks, mutual funds and ETFs are all fair game if you have a SIPP. The full list of eligible securities includes: 

  • Stocks and shares
  • Investment trusts
  • Gilts and bonds (including corporate bonds) 
  • Open-ended investment companies
  • ETFs
  • Bank deposit accounts
  • Commercial property
  • Real estate investment trusts
  • Offshore funds

Diversification is perhaps the most striking advantage of having a SIPP. By deploying capital across multiple investment categories you can reduce the overall risk of your portfolio. It’s worth pointing out that employer administered pension schemes also allow you to diversify your investments, but having a SIPP grants you more control over how your money is managed.

The wonderful tax advantages of SIPPs

Like other pensions, SIPPS are wonderfully tax efficient

Investments in SIPPs are exempt from Income Tax and Capital Gains Tax, which means you can accumulate wealth more efficiently, since your savings are free to grow without being eroded by taxation.

You also get tax relief on your pension contributions. At present, this means that the money you invest in your SIPP will be topped up by 20% by the government. So, at the time of writing, for every £8,000 you put into your SIPP, the government pays in £2,000. If you are a higher rate taxpayer, you can claim back a further 20% or 25%.

What this means on a practical level is that you can get up to 45% tax relief on the money you put into a SIPP. It operates in a similar way to an ISA, but with a larger allowance of £40,000 in 2019/20 and a lifetime contribution limit of £1.055 million.

There are also some inheritance tax benefits, if you plan to leave money to your loved ones.

How does a SIPP work on a practical level?

You set up a SIPP with a specialist provider or SIPP administrator and start making contributions. The government then adds basic rate tax relief and you can claim higher or additional-rate relief via your tax return. Over time, your contributions accumulate and with the right management and underlying economic conditions, your retirement pot grows thanks to the magic of compound interest.

It’s worth pointing out that HMRC’s rules around SIPPs are strict. You can’t withdraw funds before age 55 (to avoid paying a significant tax penalty), or invest in residential property.

Who should have a SIPP?

Here at WiseAlpha, we’re big fans of SIPPs. They work particularly well for those who want to continue investing after they retire and fund their lifestyle with a regular income.

But SIPPS aren’t not for everyone. Whilst any resident of the UK under the age of 75 can open a SIPP, in reality they tend to appeal to those who are more confident taking control of their retirement funds and managing a range of investments. 

Despite requiring a higher level of financial literacy and engagement than employer administered pensions, there’s an argument that SIPPs can make your money easier to visualise and manage, since they enable you to consolidate different pensions into one pot before you retire.

If in doubt – or you’re simply curious about whether a SIPP is the right option for you and your family – you can contact Pension Wise, the government’s free pension guidance service.

Now we’ve covered the basics, stay tuned for WiseAlpha’s next blog post on the topic of SIPPs. We’ll cover how you should go about finding a SIPP that’s right for you – and what to do when you find one.

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All information provided is true at time of publish. 

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