SIPP stands for Self-Invested Personal Pension. It is a UK personal pension scheme which allows you to select investments yourself, from the full range of options that are allowed by HMRC – Her Majesty’s Revenue & Customs – rules.
This means that you have the main benefit of a pension plan – tax relief – while maintaining the benefits of a normal investment fund – investment flexibility. You are, however, also subject to standard restrictions that apply to pensions, such as a minimum age for withdrawing funds.
The UK Pensions and their benefits
It is easiest to explain SIPPs in the context of the various types of UK pensions available under HMRC regulation. There are 5 main kinds of pensions in the UK:
State pensions: a fixed amount paid by the government to all pensioners.
Private pensions, which include:
- Workplace: pension plans offered as a benefit by employers, often with incentives like the employer matching the employee’s contributions;
- Stakeholder: pension plans set up by individuals and subject to regulation (such as limits on fees) to protect pensioners, but also subject to a low (£3,600) maximum annual contribution;
- Personal: other pension plans set up by individuals;
- Overseas: pensions set up offshore, but that are still recognised by HMRC. These include QROPS and QNUPS.
All private pensions are subject to tax relief. This means that income that you contribute to your pension is not subject to income tax, up to the following limits:
- 100% of your earnings in a year;
- An “annual allowance”, which can be carried over for 3 years. As of 2016, the standard is £40,000 per year, but it can be lower: Once you withdraw money from your pension, if you do pay in again, your annual allowance falls to £10,000 per year; If your income is over £110,000 per year, and your “adjusted income” – your income plus your pension contributions – are over £150,000 per year, your allowance falls 50 pence for every pound in adjusted income above that threshold, down to a minimum allowance of £10,000;
- A “lifetime allowance”, which as of 2016 is £1 million.
- In addition to this, upon retirement, you can draw 25% of your pension as a lump-sum, tax-free.
The remainder of your pension is subject to income tax. The rate can vary, depending on whether it is taken as a lump-sum (55% rate) or as a pension income, in which case the rate depends on your marginal rate.
Find out more: Download our UK Pensions Guide.
On the other hand, pensions are subject to restrictions on the kinds of investments that are allowed, and on the minimum age at which you can withdraw from them – usually between 60 and 65, and only below 55 in exceptional cases – such as terminal illness.
Because of this special tax treatment and regulation, pensions are often referred to as ‘tax wrappers’.
SIPPs vs. other Personal Pensions
SIPPs are, as their name – Self-Invested Personal Pensions – indicates, a type of Personal Pension.
Traditionally, personal pensions have had limited investment options. A pension fund might not have investment options to choose from – only a one-size-fits-all fund – or only have a few simple categories of funds such as ‘conservative’, ‘moderate’ and ‘aggressive’, managed by the firm that operates the self invested personal pension plan itself. Such funds are known as ‘captive’ funds, and clearly, in such a situation, once they have your money, they have a lower incentive to offer the best possible management or fees, because you cannot switch to anything different without leaving the plan altogether.
This means that while these funds have tax benefits, you might be tied to an investment portfolio that is not quite right for you, or that has mediocre investment performance.
SIPPs, on the other hand, allow pensioners to choose their own investments. This means that your portfolio can be tailored to your personal needs. If you would like to invest in a specific stock or currency, you can do so. If you are unsatisfied with a fund, you can easily switch to another one, for example.
This makes SIPPs very much a ‘tax-wrapper’ that can be put around whatever investments you want, except for a few restrictions that we discuss below. In this sense, they are similar to ISAs, except that the tax benefits generated by the wrapper are slightly different in the two cases.
As SIPPs have gained popularity over the past years, the distinction has blurred somewhat: traditional personal pensions have sought to offer greater flexibility, while some SIPPs designed to be simple and accessible for those with smaller pots now offer a narrower range of investments. There have reportedly even been a few cases of misleading marketing, in which traditional pensions with captive funds (albeit a wide range of captive funds) were marketed as SIPPs.
What can I invest in?
HMRC allows SIPPs to invest in a very broad range of asset classes that includes:
- Bonds and other fixed-income investments
- Various kinds of investment vehicles or funds, such as UCITS, OEICs, ETFs, among others
- Non-residential property
- Gold bullion
These assets can be listed – that is, quoted on an exchange – or private, and can be based in the UK or foreign.
Find out more: Download our UK Pensions Guide.
Certain assets, although allowed, are subject to punitive taxation and so are not appropriate for inclusion in SIPPs:
- Residential property
- Tangible moveable property worth less than £6,000
- ‘Luxury’ or ‘Exotic’ assets such as wine, art and collectibles
It is important to note that these are the HMRC restrictions. SIPP providers, in turn, don’t necessarily offer all these options – that varies. Not all SIPPs offer foreign investments, for example. An SIPP geared towards wealthy investors is likely to have access to a very broad range of options, while a simpler, low-cost SIPP is likely to have more restricted options.
Property investments, other illiquid investments and SIPPs
You will have noticed that non-residential properties are allowed in SIPPs. This means that you can buy a rental property like a hotel room, an office or a shop with your pension savings. If you are looking into such an investment (read the full article on investment property), investing via your SIPP could be an option because:
- As discussed above, pensions are subject to income-tax relief.
- Pension investments are protected from capital gains tax (CGT). Most other investment vehicles for liquid financial assets are too, so this tax advantage is often glossed-over. But in the case of an asset such as a property, this is a major difference vs. holding the asset directly.
- It could earn you a higher yield on your pension savings than other investment alternatives available at the time.
- It allows you to leverage your pension funds by acquiring the property with a mortgage. As compared to normal mortgages, such mortgages are subject to additional limits – such as in loan-to-value (LTV).
Note, of course, that only non-residential properties are allowed, in order to stop people from buying their own homes, which would distort the retirement-savings objective of a pension, or buy-to-let homes, which contribute to the demand that drives up house prices.
It is also important to recall that because of their size, property investments and contributions to fund them can easily exceed life-time and annual allowances respectively.
Other privately-held investments are also available, such as Private Equity. That can either mean investing in professionally managed funds which buy stakes in unlisted companies, or buying stakes in those companies directly. However, when buying stakes of companies directly, it is essential to look into the regulation in detail, to ensure that you do not breach the restriction on investing in tangible moveable property.
Find out more: Download our UK Pensions Guide.
To carry out investments in real estate and other illiquid assets, you will need a higher-end SIPP provider that offers that flexibility, rather than a low-cost SIPP.
Naturally, property investment is also available to SIPP pensioners indirectly: by buying shares in funds or companies that, in turn, invest in property.
Who are SIPPs appropriate for?
SIPPs are most appropriate for individuals who:
- Are tax-resident in the UK. Those who are abroad might be better off with a QROPS – a Qualifying Recognised Overseas Pension Scheme – which would allow them to grow their pensions beyond the UK life-time allowance and withdraw it at lower tax rates depending on their tax residence.
- Contribute over £3,600 per year. For those who contribute less, it may be best to use a stakeholder pension, which has fees that are a government-regulated percentage of the pension pot.
- Do not have access to, or already contribute fully to, defined-benefit pensions or workplace defined-contribution pensions to which their employers match contributions. For those who could contribute to these schemes, the fact that their employers would add to their own personal investments, or would guarantee an income after retirement, usually outweighs the investment performance and flexibility benefits of SIPPs.
SIPPs are ideal for investors who already have a pension pot of at least £50,000. That’s because setting up a SIPP usually involves fixed one-time fees and yearly maintenance fees. For lower amounts, the fees could eat into investment returns, and would probably not justify the tailored assistance of a financial advisor.
For those with lower amounts, it is still possible to select some off-the-shelf ‘low-cost’ SIPPs though.
Apart from the size of the pension pot and contributions, SIPPs are most appropriate for savers who are comfortable making their own investments or hiring qualified professional advisors to do so for them.
An attractive structure for consolidating your pension pots
With many of us working for over 10 employers in a career, our employer pensions are increasingly fragmented. Consolidating your pension pots can bring numerous benefits such as improved investment performance and lower fees. We discuss that in detail here.
Because they offer the most flexibility, for UK residents, SIPPs can be an ideal structure into which other pensions can be consolidated.
Can I do it alone or do I need a financial advisor?
As mentioned above, it is possible to acquire simple ‘low-cost’ SIPPs off-the-shelf directly from providers, and you can set up the more sophisticated ones too.
However, engaging a financial advisor could be helpful for two main reasons:
- Although SIPPs are appropriate for many savers, there may be better alternatives for your specific situation. An advisor will advise you on any more appropriate alternatives.
- The investment flexibility that SIPPs offers cuts both ways – the array of available investments can be hard to choose from, and it is possible to make bad choices. An advisor will be able to provide a professional recommendation of:
- SIPP providers with the most attractive fee structures and investment options;
- A portfolio that is appropriate for your needs;
- Funds and managers that have fair fees and good performance;
- Actions that you should take based on up-to-date on political and economic news that could affect your investments.
In fact, these benefits of working with a financial advisor apply to most investment and tax-wrapper products.
Who are the main service providers?
Leading providers of SIPPs include major international insurance firms and also specialised providers.
Leading insurance firms, such as Prudential, Aegon, Axa, OMI and Friends Provident are very large companies – many are in the Fortune 500 – and some have been in business for over a century. They are reputable and regarded as stable. On the other hand, they are not specialised – they also offer life insurance, medical insurance and so on – and so may have less flexibility and higher fees.
Specialised providers, on the other hand, are focused and more flexible and include Hargreaves Lansdown and Alliance Trust. Some cater more to wealthy investors who seek maximum flexibility, whereas others focus more on low-cost options.
A financial advisor can recommend the best provider for your target investment and specific needs. As always, it is important to choose a reputable firm.
What are the cost involved?
SIPP providers vary widely in terms of their fee structures. Typically, they charge several of the following:
- One-time set-up fees: these can be waived completely, or can be up to £500. A provider may charge no fee for a basic plan, but charge for a self invested personal pension plan that offers more flexibility, such as a flexible-drawdown option;
- Annual maintenance fees: these can be fixed (the £200-£400 range is common), or a percentage of your assets, such as 0.45% for amounts below £250,000 and 0.25% up to £1 million, for example;
- Trading fees: for carrying out orders to buy or sell funds or securities. These can be fixed in pounds or a percentage of the trade value;
- Various other (critics would say ‘nuisance’) fees for actions like cash withdrawals, account closure, transfers, paper statements, arrangement of death benefits, and so on.
Find out more: Download our UK Pensions Guide.
Because of this, headline fees aren’t necessarily comparable between SIPPs, and unfortunately some SIPP providers aren’t customer-friendly, and do use this to their advantage to charge higher total fees. Also, generally speaking, fees do go hand-in-hand with greater investment flexibility and support.
So the SIPP with the lowest costs is not always the best option. A SIPP with a very low headline fee might offer limited investment options, a variety of nuisance fees and poor service, while another SIPP might be more transparent in charging a higher fixed cost but offering better service, flexibility and no annoying surprises later on.
A professional advisor will have experience in knowing, at the end of the day, what the best option is for your specific needs.
What are the risks?
As SIPPs are primarily ‘tax-wrappers’, the risks your SIPP is subject to are primarily those of the underlying investments. Those investments can be selected conservatively or aggressively, and have all the normal risks of direct investment in funds or securities, such as:
- Price: the risk that an asset you buy falls in value;
- Interest rate: the risk that a change in interest rates affects the value of your investments. For example, an increase in the benchmark interest rate could cause the value of your bonds to fall;
- Liquidity: the risk that it is difficult to sell an asset you have bought;
- Credit: the risk that borrowers do not keep their promises to you.
SIPPs themselves are regulated by the UK government, and by the FCA. Private investments in property or business ventures are not, however, and are subject to greater risk.
You are also responsible for satisfying tax requirements. Inappropriate investments aren’t necessarily blocked automatically. So if it turns out that a given investment was inappropriate for a SIPP, you could be subject to a surprise tax bill.
SIPPs are a type of personal pension that offers substantial investment flexibility while maintaining the tax benefits of a pension. For this reason, it is an attractive ‘tax-wrapper’ for UK tax-resident investors with enough savings to justify the fees. Because they offer very broad investment flexibility, it is helpful to have an investment advisor to assist in choosing the most appropriate SIPP provider and investments.
For more information: Download our UK Pensions Guide.