Saving for retirement can be confusing and overwhelming, and pensions can often be difficult to understand. With such an extensive range of pension types and providers and various rules and regulations in place for both employers and individuals, it is a struggle to know which option is going to be right for you and your future.
Pensions are designed to make saving for your retirement easy, and it is vital to have some form of pension in place to support you and your family in the years to come. When choosing a pension scheme, it is essential to consider your individual needs and situation and make sure that you are picking a pension that will do exactly what you want it to.
Pensions work by investing your retirement savings into various funds to help it grow over the years, and different schemes will have different limits on how and where you can invest. Traditional pension schemes often don’t have the freedom and flexibility to invest your money where you want to, and usually require you to pay into predetermined investments. It isn’t always completely clear where or how your money is being spent with these types of pension schemes.
Self-invested personal pensions (SIPPs) are a different type of pension that allows you to take control of your retirement funds and choose where and how your money is invested. They are increasing in popularity in recent years, because of the added freedom and flexibility that isn’t available in more traditional retirement savings methods.
What is a self-invested personal pension (SIPP)?
A self-invested personal pension, or SIPP as they are more commonly known, is a type of pension that gives you greater flexibility over where and how your savings are invested. They provide a huge amount of choice when it comes to investment funds and allow you to have more control over managing your pension the way you want to.
A SIPP is a type of personal pension that works in a similar fashion to a standard personal pension but with added freedom to choose exactly where your money is being invested. They are essentially a DIY pension that allows you to personally manage your pension pot instead of relying on a pension provider to know where best to invest your hard-earned finances.
Many individuals aren’t comfortable with pension companies choosing where and how their money is being invested and would rather take control of this themselves. SIPPs give you full control over where your money goes and how it grows over time. You choose exactly how much you want to save and what investments you want to save with.
Most SIPP providers are managed online, similar to online banking, and allow you to see how much money is in your pension pot and where it is being invested. They can be used for workers wanting to save for their future with full control, for people who want to consolidate all their pensions into one place before retirement, and even for those who want to keep investing their money after they have retired.
SIPPs offer a large amount of choice for where you can invest your funds, and when you first start your SIPP it can be easy to get carried away. Be sure to take the time and effort to properly research before making investments.
How does a self-invested personal pension work?
A SIPP is a type of personal pension where you do everything yourself instead of relying on a pension provider. Traditional personal pensions usually have a limited list of investment funds that are normally run by the pension company’s fund managers. SIPPs allow you to invest in nearly any fund you like and give you the freedom to pick your own investments.
In most cases, you take no advice from the firm where you are keeping your money, and these are known as ‘execution only’ SIPPs. These are designed for individuals who have a good understanding of investing and are happy to take the time to research and work on their investments properly. These types of flexible pensions come with great responsibility, and if you make poor investment choices, then there is only yourself to blame. You should only choose a SIPP if you are confident and comfortable in picking your own investments and managing your own investment portfolio.
In addition to state pensions from the government, there are two types of pensions available; an employer pension and a private pension. A SIPP comes under the category of a private pension because you set it up yourself, although if you already have an employer pension, you may not need to consider a SIPP. Employer pensions are contributed to by both you and your employer, making it a sensible choice for workers. It is possible for an employer to contribute to your SIPP but there is no obligation for them to do so. As they are a flexible and portable pension scheme, there is no need to change anything when you stop working or if you change jobs.
SIPPs are essentially money purchase schemes, and the value of your retirement fund is determined by the number and amount of contributions, the period that each contribution has been invested and the investment growth over this period. Currently, you can start drawing from a SIPP or other retirement fund after the age of 55 (this is likely to rise to 57 in 2028), but there is no need to stop working to start taking the money out. Up to 25% of any pension fund, including SIPPs, can be taken as a tax-free cash lump sum. The remaining balance can then be used as a regular income. There is a range of different options for using a pension pot for retirement income, including an annuity and income drawdown.
Remember that unless you have opted out, or are self-employed, you will already have a personal pension thanks to new pension auto-enrolment rules. This means your employer is required to enrol you into a pension and make contributions towards your pot.
Types of self-invested personal pensions
When it comes to choosing which type of SIPP is right for you, the main thing to consider is how involved you would like to be with your investment choices. There are three main types of SIPP, and these vary depending on whether or not you want to receive investment advice on your pension or not. The three types are:
The reason these types of SIPPs are the low cost is that they come with no advice from the company that you get the SIPP from and you are in full control in how and where your savings are invested. These are a great option for individuals who are confident and comfortable in managing their own investment portfolio and making all the decisions themselves.
In some cases, low-cost SIPP providers may allow you to invest as little as £5,000, but it is recommended to transfer in a pension fund of around £50,000 or more. It is also recommended that if you aren’t transferring in a large existing pension, that you contribute several thousand pounds into your SIPP every year.
When it comes to choosing a low-cost SIPP provider, you should consider how involved you want to be in your investment decisions and the level of service you wish to receive from your provider. Some SIPP platforms offer ready-made portfolios which are ideal for individuals who aren’t ready to take full control of their investment decisions.
Some platforms offer a high level of service and extras such as mobile apps and the ability to make changes to your investments on the go. These higher service options often have higher charges, and it is important to consider whether you need to pay extra for a more comprehensive service.
A full SIPP offers a broader choice of investments than a low-cost SIPP, including commercial property. They generally include a team of experts which are available to help you make decisions on which funds to invest into and they can assist you in completing more complex investments. Full SIPPs often come with higher charges in return for the extra advice and guidance and are a good option for individuals who aren’t prepared to handle their investment decisions alone.
Due to the higher charges associated with full SIPPs, they are suitable for those with substantial pension funds; the average amount invested in a full SIP is between £150,000 and £450,000. The fees involved can be either a flat charge or a percentage of your investment, sometimes full SIPPs will have initial set-up fees as well as an annual management fee and trading charges.
Many providers require a minimum contribution every month, and this can vary between companies. It is essential to shop around for the best deal and a service that suits your individual circumstances before deciding on a SIPP provider.
Hybrid or Insurance SIPPs
These types of SIPPs are less common and are offered by insurance companies. In most cases, you are required to pay a substantial amount of money into an insurance company’s own funds before choosing your own investments. This option gives you less flexibility compared to a full SIPP. Most hybrid SIPPs will charge an initial set up fee as well as annual management fees, although these are usually capped.
Take the time to properly research all the different providers and SIPP types before deciding which option, if any, is right for you and your current situation.
Who are self-invested personal pensions for?
Anyone can get a SIPP should they choose to, but they are not always the best option for everybody. SIPPs are designed as a more flexible option for those who are comfortable and confident in making their own investment decisions, and who want a more extensive range of investment choices. You will just need to be a UK resident and under the age of 75 to open and pay into a SIPP.
In most cases, SIPPs are beneficial for those with larger pension pots or those who can make significant ongoing contributions. Many individuals will already have an employer pension that is contributed into by their employers, and these workers may not benefit from a SIPP, although it is possible for an employer to pay into a SIPP but it is not a requirement.
SIPPs can also be an excellent option for individuals who want to consolidate multiple pensions into one place, or people who want to keep investing their savings even after retirement. SIPPs allow you to keep your pension savings invested after your retirement age while still drawing down an income from it. Any existing pensions can easily be transferred into a SIPP; however, in some cases, it might be better off to leave existing pension funds where they are to get the best benefits.
If you are ever unsure about whether a SIPP is the right choice for you or are unclear on how they compare to your existing pensions, then seek the help of a financial advisor.
What can you invest in with self-invested personal pensions?
When you decide to get a SIPP, you also need to determine how and where your retirement savings are going to be invested, and most SIPPs allow you to select from a range of assets. In most cases, you can choose to invest your pension into:
- Investment trusts
- Unit trusts
- Government securities
- Traded endowment policies
- Insurance company funds
- National savings and investment products
- Deposit accounts with banks and building societies
- Commercial property including shops, office and factories
- Individual stocks and shares that are quoted on a recognised UK or overseas stock exchange
- Gilts and bonds
- Property and estate investment trusts listed on any stock exchange Offshore funds.
Different SIPP providers will offer different investment options, so these are not all the options available when you take out a SIPP.
Residential properties cannot be held directly in a SIPP due to the tax advantages that come with pension investments. However residential property can be held in a SIPP through certain types of collective investments such as real estate investment trusts, but these are always subject to certain restrictions. This type of investment is less common and not accepted by all SIPP providers.
Some SIPPs can start from as little as £50 a month, but it is important to know that the wider the range of investments, usually the higher the minimum level of investment will be.
How much does a self-invested personal pension cost?
The charges associated with a SIPP vary from provider to provider, and some can work out to be very expensive. It is vital to think carefully about what you want from your SIPP provider and decide the sort of investor you are going to be, so you don’t end up paying out more than you should.
The fees associated with SIPPs can be confusing, as there are charges for many different aspects including set up fees, annual charges, fund fees and exit fees. Look carefully at how much the SIPP will cost you while you are saving and paying money in, and then also look at how much it will cost to access your pension in your retirement. It might be tempting to choose a platform that is cheap during your saving but charges a lot in your retirement to access the funds. These are the main charges to consider and ask about when choosing your SIPP provider:
Set up charges
With some SIPP providers you will need to pay a one-off set up fee to get started. These could be anywhere between £0 to £500 so be sure to ask any new potential platforms about their set up charges before committing to anything.
Annual admin charges: These can also be called platform fees and are a yearly cost for having a SIPP. This might either be a flat fee, usually between £100 and £500, or a percentage of your investment amount such as 0.5% to 0.75%. Not all SIPP providers will have an annual admin charge.
Annual funds and shares charges
Some SIPP platforms charge a yearly fee for shares and funds. Like with annual admin charges, these can either be a flat fee or a percentage fee. However, most platforms that do charge a percentage fee do not also have yearly admin charges as well. Some SIPPs will charge you for investing in funds and shares, and then also charge you every time you make a trade, so it is essential to know if you plan to be an active trader or not.
Every time you sell or buy an investment you will need to pay dealing charges which can be anywhere up to £12.50 per trade. There are some SIPP platforms that charge dealing fees for shares but not for funds.
Transfer and exit charges
When you move money into a SIPP, either from another pension, as a lump sum or from shares, then you could get charged transfer fees. You could also be charged exit fees if you choose to move your funds out of your SIPP. Transfer and exit charges vary a lot between providers, but on average will be around £50.
Income drawdown charge
Once you reach retirement age and can start to draw down from your SIPP then you will have to pay income drawdown charges. These usually include an initial set-up fee which can be up to £300, and then also an ongoing annual fee of up to £150.
Make sure you thoroughly research and compare SIPP providers available to you and add up all the various fees and charges to work out which is the best option for your circumstances. Keep in mind how you plan on using your SIPP and if you are going to be a very active trader or not.
Is there tax relief with self-invested personal pensions?
All pension schemes qualify for 20% tax relief on the money paid in, and SIPPs are no exception. The annual limit for tax relief on pension contributions is currently £40,000. If you are paying a higher rate of tax, you will be able to claim back even more with your tax return.
Any money invested in your SIPP can grow free from UK capital gains and UK income tax. When it is time to take money out of your SIPP, you will be able to take up to 25% as a tax-free lump sum and the remaining 75% will be taxed as income.
If you are a basic rate taxpayer, paying 20% tax, then when you invest £100 into a SIPP you will only pay £80. For higher rate tax payers, paying 40% it will only cost £60.
What happens to a self-invested personal pension after you die?
When deciding on a pension scheme, it is important to consider what happens to your savings after you’re gone. If you have a SIPP set up and pass away before taking any money out, then it will be passed on tax-free to your beneficiaries. If you die before the age of 75, then your beneficiaries can take the entire pension fund in your SIPP as a tax-free lump sum. Dependants (but not any other beneficiaries) could choose to drawdown or buy an annuity to use your pension savings as a regular tax-free income.
If you pass away after the age of 75, then your beneficiaries can choose to either take the whole fund as a cash lump sum, take regular income as an income drawdown or annuity (only available to dependants), or take periodical lump sums. No matter which option they choose, the payments will be treated as their own income and will be subject to income tax at their current tax rate.
Make sure your family and beneficiaries are aware of the type of pension and savings you have and help them to understand their options should anything happen to you. SIPPs can be confusing, so it is best to give them as much knowledge and information as you can.
Advantages of self-invested personal pensions
As with any pension product, SIPPs come with their benefits and drawbacks, and it is important to properly understand all of these before deciding if it is the right choice for you and your retirement savings. The advantages of a SIPP are:
More investment choices
Unlike with traditional pension schemes, SIPPs can be invested in a wider range of options such as shares, gifts, trusts, commercial properties and insurance companies. With a SIPP, you are not limited to a small selection of investments and depending on the provider you can invest your savings any way you like.
Greater freedom and flexibility
With a SIPP you are in charge and free to make all the decisions yourself. You do not need to rely on a pension provider deciding where and how your savings are invested.
Ability to move investments
If your investments are performing badly and negatively impacting your retirement savings, you can easily move the funds to a different investment.
Low monthly contributions
With some SIPP platforms, the minimum monthly contributions are as low as £50, although this isn’t always the case so be sure to research carefully.
Invest in commercial property
SIPPs allow you to invest your savings into commercial property, which is not possible with traditional pension schemes. There are some tax advantages in using a SIPP to invest in commercial property as rent can be received tax free to your fund.
Transfer existing pensions
If you have one or more existing pension, you can easily transfer them into one place with a SIPP, making it easy to manage all your retirement savings in one place.
Pay in lump sums
With a SIPP you can pay in cash lump sums as and when you please, as long as you don’t exceed any of the current tax year limits. This means if you have other savings outside of your pension you can consolidate everything into one place.
SIPPs can be topped up with lump sums if you have them available, but your pension savings cannot exceed £40,000 in 2018/2019 tax year.
Disadvantages of self-invested personal pensions
SIPPs have their obvious attractions, but that does not mean they are suitable for everybody. It is important to weigh up the downsides when considering if a SIPP is the right pension product for you. The disadvantages of a SIPP are:
SIPPs are not a pension that can simply be set up and left to its own devices, they take time and effort from you to work efficiently. You will need to spend time managing your investments and researching the best next steps to take.
You’re on your own
Unlike with traditional pension schemes, you are completely responsible for investing your own money when you choose a SIPP. You must come up with your own investment strategy or pay extra for someone else to do it on your behalf.
Not designed for small sums
If your pension savings are on the lower end of the scale, and you can’t contribute a large amount every month, then a SIPP might not be the best choice for you. Although you can open a SIPP with as little as £5,000, you need to top this up significantly to make them worthwhile.
No employer contributions
All workers are entitled to an employer pension where your employer will be making contributions to your pension pot in addition to your own contributions. It is possible for an employer to pay into a SIPP but highly unlikely as it causes additional admin and work for them, compared with using their own employer scheme.
The fees and charges associated with SIPPs can add up to be very costly. With some providers charging both annual admin fees and annual funds and shares charges. Many SIPP providers are also pricey when it comes to removing and transferring your funds out.
One of the biggest downsides of a SIPP is the higher risk involved than with a traditional personal pension. As you are responsible for all the investment decisions, you only have yourself to blame if this go wrong. It is possible to make poor investment choices and significantly impact your retirement savings.
In most cases, SIPPs require more transactions and more moving investments than a traditional pension. All these additional transfers and changes result in higher administrative costs which can make SIPPs an expensive option.
A SIPP is only as risky as you make it, as you are in charge of your investments. If you are confident in investing and choose to invest in low risk funds, then the level of risk associated will decrease greatly.
In summaryA SIPP is a great alternative to traditional personal pensions for individuals who are looking for more control and flexibility over their retirement savings. They still follow all the same laws and regulations as other pension schemes; however, they provide you with more freedom in where your money can be invested.
SIPPs should only really be considered if you have experience in investing and are confident and comfortable making big decisions that will affect your future. It is always worth seeking independent financial advice if you are unsure if a SIPP or other pension scheme is right for you and your individual situation. Be sure to discuss and weigh up all the advantages and disadvantages of a SIPP and calculate the fees and charges before committing to one provider.
As SIPP platforms do vary significantly, it is vital to shop around and research to make sure you find the best option for you.