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SIPPS Explained

 

What is a SIPP?

 

 

Please note the value of investments, and any income from them can go down as well as up and you may not get back your original investment. We do not offer advice about the suitability of our products or any investments held within them. Should you require financial advice you should consult a suitably qualified financial adviser.

 

The Pensions Industry is mad on acronyms and abbreviations and here's one more for the collection: SIPP. Self-Invested Personal Pension.

Up until the late 80's most pension schemes were company ones and they were often very good, but they became frighteningly expensive and many closed. The gap was filled by old-fashioned self-employed policies, dressed up and re-launched as Personal Pensions. These were run by insurance companies and generally worked very well, but many people wanted to choose their own investments.

The legislation for SIPPs, offering far wider investment powers, has been around since 1989 but it's only in the last few years that they've really taken off. People have grown to like the sense of ownership a SIPP confers; it's not like an employer's scheme where you have no say in how it's run, you aren't at the mercy of some faceless institution; you can speak to your SIPP Provider and say what you'd like to do, because your SIPP is yours.

You could say that a SIPP is the only truly personal pension. Besides institutional investments you might for instance want to buy a property with your pension scheme, possibly your own office or workshop. You may find that not all the things you want to invest in are on your insurance company's menu. One size has its place but it doesn't necessarily fit all. Subject to what Regulators and HMRC will allow, a SIPP is about diversity and freedom of choice. It's a box to put your treasures in.

 

Funding a SIPP

A SIPP gets its money from one or more of:

  • Transfers from other pension schemes, mainly personal pensions seeking a new lease of life
  • Contributions from Employers, on which the company will usually get Corporation Tax relief
  • Personal contributions, on which we can reclaim tax - see next bullet point
  • Tax relief on Personal contributions. Money paid in is assumed to have been taxed at Basic Rate, currently 20%, so a 'net contribution' of £800 represents earnings of £1000. We can reclaim the £200 difference so there's an immediate 25% boost!
  • 'In specie' transfers, where an asset such as shares or a property is transferred into the SIPP instead of cash

Higher rate tax payers can reclaim the other 20% via their annual Tax Returns, but this reduces personal tax and doesn't go into the SIPP - unless you choose to put it in!

 

What can I invest in?

 

Please note the value of investments, and any income from them can go down as well as up and you may not get back your original investment. We do not offer advice about the suitability of our products or any investments held within them. Should you require financial advice you should consult a suitably qualified financial adviser.

 

There was a time when a SIPP could buy paintings, racehorses, vintage cars or fine wine but such frivolities are now effectively banned. There was also a proposal to include such things as buy to lets, but the politicians changed their minds. Even so the investment choice available is huge.

Without claiming that the list is exhaustive, the main categories are:

  • Bank accounts. This is always the starting point as all cash first comes into the SIPP's own account before being channelled into other investments. A bank account can itself be an investment, if it's thought to be sufficiently attractive
  • Savings Bonds such as NS&I (National Savings & Investments)
  • Stocks and shares
  • Gold bullion (but not silver!)
  • Investment 'Platforms' which cover a wide range of bonds and investment company funds, and some also deal in stocks and shares, so almost everything is under one umbrella
  • Commercial Property -- a big area with its own section below
  • Land, either agricultural or for development

Investment income such as rent and interest is generally paid tax-free. Sometimes it's taxed but tax can be reclaimed. Dividends are always taxed.

 

Property in a SIPP

A property is a great investment especially in a healthy economy where its value is increasing, and if there's a tenant the SIPP also gets a tax-free income which is often better than most other investment products offered. Furthermore you don't necessarily have to sell it when you retire, as what comes in as rent can, subject to certain limits discussed later, be paid out as a pension.

It does have to be commercial which generally means it can't be lived in, with the possible exception of, say, a caretaker's flat provided as a condition of employment. Classic SIPP properties are offices, shops (but not the flat upstairs), corrugated iron sheds on industrial estates, pubs and farms, but needless to say not the farmhouse. Some offices might have started off as posh houses but so long as the change of use has been documented that's no problem. Land is ok even if houses are being built on it, but it must be sold before the houses are habitable.

A lot of people buy their own premises with their SIPP. Their firm gets expenses relief on the rent, the rent is tax-free and in the long term there should be capital appreciation. If the firm falls upon hard times the creditors can't touch the property. The only thing is that with 'connected parties' both the purchase price and rent have to be strictly in line with an independent value.

If necessary a SIPP can borrow up to 50% of its net value. In theory it could do this for any investment but it's usually for a property purchase. The lender will set out its own conditions, for example the lease will usually have to be at least as long as the repayment term.

Some properties are subject to VAT, and with certain exceptions this means VAT is added to the purchase price but can be reclaimed by the SIPP. It also has to be added to rents, and the SIPP then has to pass the VAT element to HMRC. The tenant may be able to reclaim his VAT.  If there's development work the SIPP can reclaim the VAT on the bills. There is no particular logic as to why some properties are VAT-able and some aren't; it's just historical

Properties are usually bought but can also be transferred in from other pension schemes, or contributed 'in-specie'. Either way the process is much the same as buying.

Property in a SIPP
 

How do I take a pension?

 

A pension scheme's purpose is to give you an income in retirement, but the option of taking a tax-free cash sum, usually 25% of the fund, is much loved.

There are 3 ways of taking a pension in a Liberty SIPP:

Buy an annuity from an insurance company

An annuity is rock solid. Its terms - the pension amount, whether it will increase, whether there's a spouse's pension, what happens when you die - are set out in your schedule and will never vary. To buy an annuity you hand over a large lump sum to the insurer and it's no longer yours; they in turn fulfil their obligations under the contract.

The biggest pension you can buy for a particular price is a fixed pension for you alone. Usually there will be a guarantee so that if you die in the first 5 years the insurers will pay a lump sum and your money isn't all wasted. However all 'bells and whistles', including the guarantee, reduce the amount of your pension. Sometimes special circumstances such as ill health or a history of smoking may result in a higher pension.

An annuity is valuable for its certainty but certainty comes at a price, as any annuity is bound to be quoted on cautious assumptions. It will also be based on current economic conditions and won't change if, for instance, interest rates rocket in the future.

Pay a pension direct from your SIPP or PP. This is known as Drawdown

Flexi Access Drawdown (FAD) is a brand new way to take retirement income from a pension. It gives you full flexibility on how much you would like to take per month, per year or ad-hoc. One of the main benefits of FAD is that you can keep your pension invested whilst drawing down income.

You can split flexi access drawdown into 2 parts:

  1. Tax free cash (usually 25%);
  2. Taxable income (usually the remaining 75%).

When you start drawdown you get the option to take 25% completely tax free. This is usually paid out to you when you commence drawdown. This is known as the Pension Commencement Lump Sum (PCLS).

After you have taken your lump sum you have the option to take as much of the remaining 75% as you’d like – but you will pay your marginal rate of tax on each income payment. If you took a large amount of taxable income in a single tax year it could push you up to a higher rate of income tax, especially if you haven’t fully retired and are still working.

Take flexible lump sums through UFPLS

Another new option for taking money out of your pension will be the ability to take flexible lump sums from all or part of your pension pot that hasn’t been used for drawdown. These will be known as Uncrystallised Funds Pension Lump Sum (UFPLS).

They will work like this…

  • 25% of every flexible lump sum will be tax free; and
  • You will pay your marginal rate of tax on the remaining part of your flexible lump sum.

This works differently to flexi access drawdown as each UFPLS payment has an element which is tax free (25%).

One final thing. If you buy an annuity that's it for life, but you can stop drawdown at any time and buy an annuity with the remaining fund. For example you may no longer want to live with the investment risks inherent in Drawdown, or it you may want to consider an annuity appropriate to a changing health situation.

You could also do 'half and half': take pensions at the same time partly by Drawdown and partly by buying an annuity.

 

What's the difference between SIPPs and other pension products?

When Samuel Pepys retired, his replacement had to set aside part of his salary to provide Samuel with a pension. We needn't go quite so far back but a little history will do no harm.

Originally most pension provision was done by employers and a lot of schemes were on a 'final salary' basis which promised pensions on a set formula based on your latest earnings and length of your service, irrespective of what it cost. For employees it was brilliant; you might have joined the company in 1960 on £500 per annum and retired in 1980 on £15000, and you'd get 20 years worth of pension, all based on £15000.

This didn't happen overnight and schemes took many years to evolve but just when many were approaching their peak of perfection, the whole financial and employment climate changed drastically, and suddenly firms no longer needed to entice workers with a Rolls Royce pension scheme, nor could they afford to.

Enter Personal Pensions, propelled by a formidable sales culture. As a result thousands of final salary schemes were closed. Whilst they ceased to provide benefits for the future, what members had already earned couldn't be taken away, but tempted by projected returns which seemed realistic at the time, people transferred their final salary benefits to Personal Pensions in droves.

A Personal Pension, as with any other 'Money  Purchase', or 'Defined Contribution' arrangement as the Americans perhaps more clearly express it, is just a pot of money, and the amount of pension it will buy depends on how well its investments perform and the cost of pension at retirement. Unlike a final salary scheme, it makes no promises.

A few years ago Stakeholder pensions were introduced and these are very similar, except that they place particular emphasis on minimising charges. We now have Workplace Pensions to which employers, depending on their size, will gradually be obliged to contribute. All of these are based around provision by one insurance company and the investment choice will be what that company allows, though it may offer a huge choice of funds. Even so there's an implied restriction.

The idea of SIPPs and almost total investment freedom was first mentioned in the 1989 Budget and it seems amazing now, bearing in mind the massive body of rules now governing pensions, that the permitted investments were set out in a one page Inland Revenue document known as Memorandum 101 - please see the list above.

There is a growing trend nowadays towards more middle of the road investments, especially for smaller funds, but come what may the additional opportunities available under a SIPP are more than enough to distinguish between having a scheme that's very much your own, and being bossed by an financial institution.

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