Dissatisfaction with insurance company pensions and the greater
pensions flexibility available since April 2006 is driving a boom
in self invested personal pensions, or Sipps.
The principal advantages of Sipps are the wide range of
investments you can place in them and the facility to take income
from your pension funds between the ages of 50 and 75, without
having to buy an annuity. This gives you much more control over
your retirement fund than ever before.
Spoilt for choice
There are around 140 Sipp providers in the market to choose
from, offering everything from ‘online’ Sipps which restrict
investment to share trading and mutual funds, to ‘full’ Sipps which
allow you to invest in a very wide range of investments and
externally managed funds.
You can also choose whether you want to take advice on the
investments you make via an independent financial adviser, or
whether you wish to go it alone.
So the Sipp provider, the investments and the advice can all be
chosen separately, giving you the opportunity to choose the ones
you feel most comfortable with.
What is a Sipp?
Sipps are effectively an upmarket version of the personal
pension and in many ways are similar to them. Current contribution
limits in the 2007-08 tax year (100 per cent of your earned income,
subject to a cap of £225,000) and the way in which you take
benefits are exactly the same as for personal pensions.
What can I invest in?
A ‘full Sipp’ allows you to invest in equities, mutual funds,
investment trusts, bonds, Oeics, offshore funds, insured funds,
gilts, unlisted shares, commercial property, hedge funds, private
equity and cash.
The majority of investments will not incur any tax charges in
terms of income tax and capital gains tax (other than advanced
corporation tax payable on UK dividends).
Some other investments, such as residential property, antiques
and personal chattels, such as stamps, gemstones and yachts, may be
taxed at up to 70 per cent.
Shares
A Sipp can purchase shares in any company, regardless of whether
or not they are listed on a recognized stock exchange, but HMRC
(formerly the Inland Revenue) might impose restrictions on shares
in connected companies.
Property investment
There are many advantages in a pension scheme owning property or
land, including:
no capital gains tax liability when the property is sold;
normally there will be no inheritance tax liability as the
property is an asset of the scheme (with the exception of
alternatively secured pension where inheritance tax may apply);
the rent paid by the tenant is tax deductible as a business
expense, and
the rent received by the pension scheme helps to increase the
retirement benefits.
However, you should remember that property is an illiquid asset
and will require ongoing maintenance plus regular tenants to
generate good returns.
What type of direct property can a Sipp purchase?
Commercial property, including:
hotels
student accommodation
care homes
shop
offices
Can a Sipp borrow?
A Sipp can borrow on commercial terms a maximum of 50 per cent
of the current value of the scheme, less any outstanding loans. All
of the scheme assets, plus any scheme borrowings, can be used to
purchase an asset. This means that the scheme could buy an asset
worth 150 per cent of the current value of the scheme.
Can a Sipp make loans?
Up to 50 per cent of the market value of the scheme can be used.
So if your fund is worth £400,000, you could borrow up to £200,000,
making a purchase of a £600,000 property possible. The loan should
not be granted for more than 5 years, but under certain
circumstances the loan can be extended by up to 5 years.
A Sipp cannot make a loan to you or a connected party
What are the costs of investing in a Sipp?
There a several layers of charges associated with Sipps: an
initial set up fee, an annual management charge and dealing charges
on whatever investments you decide to place within your Sipp.
Whichever type of Sipp you choose, it is important to check that
the charging structure is cost effective for the type and
frequency, of investments you expect to use.
Who can invest in Sipps?
Sipps are available to anyone from birth to age 75. They are
best suited to financially confident people who have already built
up a pension pot and will continue to contribute. Even if you are
not financially savvy, many Sipp schemes have links to a
stockbroker who can manage your fund for you. Alternatively, you
can use your own adviser.
Can I contribute to a company scheme as well as Sipp?
Yes. since April 2006, it has been possible to invest in as many
different pension schemes as you want and to invest 100 per cent of
your earned income up to £225,000 (in 2007-08) with full tax
relief.
You can contribute more than the annual contribution limit, but
you will be taxed at 40 per cent on any contributions in excess of
the limit.
If you are a member of any type of company pension (such as a
final salary scheme, group money purchase or group personal pension
scheme), you can invest in a Sipp as well.
Lifetime allowance
When making contributions, it is also advisable to keep an eye
on the lifetime allowance of £1.65m (2007-08) which is the maximum
size pension fund you can draw on at retirement without suffering a
tax penalty.
How do I get started?
You can start a Sipp with a monthly contribution of as little as
£50 a month or with a transfer value from another pension
arrangement of £20,000-£30,000, although some providers prefer
higher contributions and larger initial lump sums.
For a list of Sipp providers and contact details, visit
www.ampsonline.co.uk
Should I amalgamate my pensions?
For some people, it may make sense to amalgamate some, or all,
of their pensions within a Sipp so that they have all their pension
funds under one roof.
However, this is a very complex area and you should take
specialist advice from a G60 qualified independent financial
adviser (IFA) To find an appropriately qualified IFA in your area,
visit www.unbiased.co.uk
Some individuals in occupational schemes who want to take income
drawdown in retirement may be advised to transfer their fund into a
Sipp shortly before retirement because drawdown is not always
possible from a final salary scheme. Buy you should seek specialist
advice on this as well.
Taking income drawdown
If you don’t want to purchase an annuity when you come to
retirement, you can do this by taking income drawdown.
This involves taking up to 25 per cent of the fund (including
the value of additional voluntary contributions) as tax free
cash.
The maximum income you can take in any one year is roughly equal
to 120 per cent of what a level, single life annuity would pay
someone of your age, while there is no minimum income
requirement.
This means that you can choose to take no income each year if
you so wish.
To ensure that the income limits from drawdown are in line with
annuities, the limits are calculated by reference to current gilt
yields. The Government Actuaries Department (GAD) produces a set of
special tables based on a range of interest rates.
Income can be varied each year (as long as it is kept within the
GAD limits) and can be paid monthly, quarterly, half yearly, in
advance or in arrears.
There is a compulsory review of income drawdown arrangements
every five years to ensure that your pension fund can sustain
future income payments. At the review, the minimum and maximum
income limits are set for the next five years.
Alternatively secured income
ASP is an option which has been available since April 2006. It
allows you to avoid having to purchase an annuity at the age of 75
by continuing with a restricted form of income drawdown.
For many years, the government and the Revenue resisted pressure
to abolish the compulsion to buy annuities at age 75. They argued
that pensions are designed to provide income in retirement and
should not be used to allow individuals to pass their pension funds
to their families.
So it was a welcome surprise when, as part of radical changes to
pensions that were introduced in April 2006, that the government
introduced this new option.
However, the attractiveness of ASP was greatly reduced when, in
December 2006, the rules were changed so that the option to leave
unused ASP funds to individuals who are not financial dependants
will attract an effective tax charge of 82 per cent.
Income limits
Alternatively Secured Pension or ASP will be paid to an
individual from their pension fund in much the same way as for
income drawdown before age 75.
The maximum permitted income is roughly equivalent to 90 per
cent of what a single life, level annuity would pay to someone aged
75.
The minimum income is 55 per cent, also based on what a single,
level annuity would pay to someone age 75. But as you grow older,
the maximum income will still be based on the equivalent annuity
payment for someone aged 75.
The income limits are reviewed each year, and the amount of
income you take within these limits can be changed accordingly,
providing you do not exceed the upper limit.
Death benefits before age 75
If you die before age 75 and have not started taking your
pension, your entire pension fund can pass to your estate tax
free.
If you die after you have started taking income drawdown, your
fund can pass to your estate, less a 35 per cent tax charge.
Alternatively, your spouse or registered civil partner can use
the fund to purchase an annuity or continue taking income
drawdown.
Death benefits after age 75
Any remaining ASP funds can be used to provide benefits for any
surviving financial dependants. Your spouse or a registered civil
partner will be considered a financial dependant, as will children
under the age of 23, if they are in full time education.
Benefits paid to dependants can only be paid in the form of
income, so they can’t receive a lump sum as a death benefit.
Income can be paid as:
a lifetime annuity;
income drawdown, if the dependant is under age 75; or
ASP, if the dependant is over age 75.
If there are no surviving financial dependants, the remaining
funds can be paid as a lump sum death benefit, with the payment
made to:
a charity of your choice, in which case it will be entirely tax
free;
other individuals (who are not financial dependants), or to
other pension funds, in which case the payments will be treated as
‘unauthorised payments.’ Any such payments may incur a tax charge
of up to 82 per cent (a 70 per cent tax charge on the pension fund
and 40 per cent inheritance tax thereafter).
Phased retirement
This is a very tax efficient way to take your pension income.
Your pension plan is set up with a number of different segments and
each year you convert a number of these segments into tax free cash
and an income bought via a mini annuity.
Each converted segment is taken partly as tax-free cash (up to
25 per cent) and the remainder as an annuity.
The tax-free cash is added to the annuity and the two together
provide income for that year. As a large part of the total annual
income comprises tax-free cash, it is clearly very tax efficient as
income tax is only applied to the annuity element.
In subsequent years, further encashments are made to provide
more tax-free cash and income, in addition to the annuities already
in payment.
This means that a number of different annuities are purchased
over time and each one could be purchased on a different basis,
such as with profits, investment-linked, single or joint life,
level or escalating.
Group Sipps
Some employers are setting up group Sipps for certain groups of
employees. If you belong to a group Sipp, your employer can make
unlimited contributions to your pension with full tax relief
(providing your employer can justify the size of the contribution
to the taxman).
But any contribution (whether from the employee or employer)
which takes total contributions over the annual limit (currently
£225,000), will result in a ‘benefit-in-kind’ income tax charge on
the employee.
So if an employee contributes £300,000 and the employer
contributes £300,000 as well, the employee would have to pay a
benefit-in-kind charge on the entire excess over £225,000 – in this
case, on £375,000.
Regulation
Sipp providers have been regulated by the Financial Services
Authority since 6 April 2007. However, some specialist investments
such as property, hedge funds and private equity funds are not
regulated.