Let’s play word association. If I say ‘pension’ what words spring to mind? Let me hazard three guesses: boring, inflexible and complex. Am I right? Probably. But there is a type of pension scheme where you don’t surrender control to a faceless manager, where you can take all the decisions and can even invest in a variety of investments which you would not normally associate with the word pension.
This is the world of Self-Invested Personal Pensions (Sipps), a product that requires more effort than a standard pension but allows you to do it yourself, take control and plot a path to get rich slow.
Sipps have been around for many years but were originally seen as a very obscure type of pension. There were only a few thousand sold each year, mostly to either quite nerdy ‘pension hobbyists’ or to individuals who could afford to employ a professional adviser to manage their Sipp for them.
This lack of sales volume meant charges were generally higher than with a standard pension plan (where you invest cash with an insurance company and they put it into a fund which is then managed by a professional management team).
How does a Sipp work?
Sipps are the antithesis of this approach, as the saver decides where there pension cash is invested, whether it be commercial property, cash savings, shares, bonds, investment funds or exchange traded funds (which track a particular investment market such as the FTSE or even commodity prices).
The Sipp is basically a tax-efficient wrapper inside which the investments are held. In recent years they have started to move into the investment mainstream as more and more people have become concerned about their retirement provision and looked to take control.
As the number of Sipps that have been opened has increased, the charges have dropped and the options over what investments which can be held in a Sipp have increased. It used to be the case that the investments on offer through a Sipp were broadly the same as a standard pension and all you were doing by going down the Sipp route was managing the mix of these investments yourself rather than paying a manager to do it.
However, now Sipps offer not only the standard fare of bonds, shares and cash but also more exotic investments such as commercial property, venture capital trusts (which in turn usually invest in small and medium-sized businesses), endowment products and good old-fashioned National Savings and Investment products.
In essence, Sipps now offer an investment mix which can cater for the risk averse all the way to the risk takers in life. Unlike many pension products – or financial services products for that matter – Sipps are in a virtuous circle of growing popularity, falling charges and greater choice.
[From our partners: A free guide to SIPPs]
Tax relief on SIPPs
“Over recent years, the charges associated with Sipps have come down significantly, particularly those relating to the ‘simple Sipp’; the ones which allow you to invest only in funds and stock market investments,” says Catherine Penney, Vice President at Barclays Stockbrokers.
In fact, she adds, for investors over the age of 50, a Sipp should be seriously considered before subscribing to ISAs, since the tax reliefs available make them significantly more beneficial.
Like a standard pension such as one available through an employer, a Sipp gets tax relief at either 20, 40 or 45 per cent, depending on your income tax liability. This means in effect at the top end of the income scale, for every £1,000 invested in a Sipp, you get a tax relief top up of £450.
A return like this would take many years to achieve through a high street savings account but with a Sipp it arrives on day one in the form of tax relief.
The tax advantages don’t stop there. Investments held within a Sipp can grow free of Capital Gains Tax and income earned on assets is also off limits as far as the taxman is concerned. It is also possible for a Sipp pension holder to borrow up to 50 per cent of the value of the assets held within the pension.
The reason you would do that is to enable you, as the Sipp holder, to buy other assets. For example, say your Sipp has £100,000 of assets in it, you can borrow £50,000 in order to buy more assets. Of course, the value of these assets can go down as well as up and the money plus interest on the loan will have to be repaid, but it can be a very good way to supercharge your investment.
[From our partners: SIPP tax benefits]
Withdrawing your cash
How about getting your cash out? At present when you reach age 55 you can take up to 25 per cent as a cash lump sum and the rest then can be used to either buy an income for life – called an annuity – or can remain invested to hopefully grow some more.
But this is going to change with the government about to set out plans to allow investors to skip the buying of an annuity altogether. It will be possible soon to take your whole pension as a cash lump sum. But there is likely to be quite substantial tax disincentives put in place to combat the risk that people will take their cash and blow it (on a nice Lamborghini, perhaps?).
But there is one cloud on the horizon, and that is the prospect of new rules designed to ensure that pension companies can always pay back the cash that investors have paid into their funds (this is a good thing, of course). But as a result of these new ‘capital adequacy rules’ it may mean in due course that some of the less standard, more exotic, investments are no longer offered by providers.
That, though, is in the future and the wrangling goes on behind the scenes between providers and regulators.
All in all, though, Sipps are moving from the periphery into the mainstream because they offer that rarest of things in the world of financial services: control. Not normally a word you associate with pensions.
[From our partners: Online application for the Vantage SIPP]