A hands-on way to grow your pension pot
The cost of taking out a self-invested personal pension (SIPP) has dropped significantly as competition heats up between providers.
SIPPs are a form of pension plan in which investors may choose from a wide range of investments. Many assets which may not be held in a simple personal pension - such as cash holdings, shares (including those listed on the Alternative Investment Market), non-regulated investment funds and commercial property, as well as a host of more unusual investment vehicles - can be held in a SIPP.
There are now several providers of low-cost SIPPs, meaning that this type of pension is no longer the sole domain of those with very large pension funds.
While SIPPs were once regarded as specialist investment vehicles for those with funds of at least £100,000, they are now being offered to investors with funds of as little as £10,000, and the line between standard personal pensions and SIPPs is becoming increasingly blurred.
Since simplification of the pension rules in April 2006, investing in pensions has become more transparent and straightforward. For instance, the old concurrency rules, which stated that you could not invest in an occupational pension scheme as well as a personal pension, have been scrapped. This means that you may invest your annual allowance of 100% of your income, up to a maximum of £225,000 this year, across as many different pension plans as you wish.
Therefore, even if you already have an occupational scheme and a personal pension plan, you can still start a new SIPP as well, giving you much more freedom over how and when you make pension contributions.
More money, more choice
Different SIPP providers offer different types of investments that you can choose from. The general rule is that the more there is to choose from, the higher the cost of the SIPP. Very low-cost SIPPs, therefore, may only offer an enhanced range of funds, plus stocks and shares on top of what a personal pension would offer, whereas most full SIPPs offer everything.
For example, the Freedom SIPP allows investors to choose from anything approved for SIPP investment, including funds, shares, commercial property, warrants and covered warrants, spread betting, traded options and traded endowment policies (TEPs). However, charges are high. The annual charge is £890 plus VAT, and there is a set-up fee of £390 plus VAT. You will also have to pay additional administration charges for specialist investments on top of this.
At the other end of the spectrum, SIPPdeal charges a one-off fee of £100. It offers access to shares, including AIM shares, investment trusts, and warrants and covered warrants. It also offers access to nearly 2,000 unit trusts and open-ended investment companies (OEICs), but none of the more esoteric investments accessible with a full-blown SIPP.
Similarly, the Hargreaves Lansdown Vantage SIPP, which has no set-up or annual fee but does charge 0.5% for share deals up to a maximum of £200 plus VAT a year, only offers access to cash, shares (including those on AIM), and funds.
Other SIPPs with no set-up or annual charges are offered by James Hay and Alliance Trust, which provides access to over 3,000 shares and investment trusts via its Select SIPP. Interactive Investor also offers a SIPP with no set-up charges but makes a quarterly administration charge of £18.50 on holdings valued at £50,000 and under.
These are just a taste of what is on offer from SIPP providers - and many will allow you to view, research and make investments online. Most do not expect large contributions - for instance, Hargreaves Lansdown will accept monthly contributions to its Vantage SIPP of as little as £50.
If you invest in funds within your SIPP, you will pay the annual management fee on each of the funds you choose, and an initial charge. However, the majority of SIPP providers will be able to offer good discounts on initial charges. "You do not need to contribute large amounts to a SIPP to make it worthwhile," says Tom McPhail, head of pensions research at IFA Hargreaves Lansdown.
In order to decide whether a low-cost SIPP would suit you, as opposed to a full-blown SIPP or indeed a more basic personal pension plan, you need to consider your own risk profile and the investments suitable for that.
In reality, only a small minority of investors will want to put commercial property in their SIPP - for example, a group of barristers might join their SIPPs together to buy their chambers premises. Those who have very large funds and can risk a bit on more unusual investments will probably be able to afford the higher charges of full-blown SIPPs. But many more may wish to deal shares, or be able to hold cash at certain times, which can be done with a low-cost SIPP.
Alan Steel, from IFA Alan Steel Asset Management, based in Linlithgow, West Lothian, says: "The vast majority of people are not going to need access to many of the more esoteric investments and commercial property, so a standard personal pension or low-cost SIPP is adequate. If you are adamant that you want to deal in shares in your pension, then you will need a SIPP."
McPhail agrees: "Investments in cash, funds and share trading is all most people will want to do with their SIPP - that will cover 98% of the market."
Wide range of funds
Even if you only wish to invest in funds, using a SIPP will give you a very wide range. McPhail adds: "Quite often when new funds are launched, they are instantly available for SIPP investments, but not standard personal pensions." By choosing a SIPP, you can also keep your options open to decide later on to branch out to other investments, such as shares, if you wish, he says.
But Steel warns that it is wise not to get carried away with your SIPP, and you should exercise caution with the investment choices you make. "Some people may have unrealistic expectations of performance in a SIPP. Don't forget that it is possible to lose your shirt by buying and selling shares and this is your retirement fund."
If you already have an occupational pension scheme and/or other personal pensions, you do not need to convert them into a SIPP - you can hold a SIPP in addition to these. However, if they are very restrictive in terms of investment, or you are unhappy with performance of the underlying investments, and would rather be able to choose the best funds instead, you can consider transferring your holdings to a SIPP.
Another option, says McPhail, is to consider using a SIPP to top-up contributions to a money purchase occupational scheme rather than an additional voluntary contribution (AVC) fund, which might have more limited investment choices. "As for occupational schemes themselves, you should leave final salary pension schemes where they are, if you have them," advises McPhail.
"But if you have deferred benefits from a money purchase scheme, perhaps with an employer you no longer work for, you could consider transferring those to a SIPP. You must take advice, however."
Similarly, if you have money in a pre-1987 final salary scheme or director's personal pension, you should be very careful about switching. In many cases, these types of fund allow holders to take 50% of the resulting fund as a tax-free lump sum, rather than just 25% as is now the rule. If you switch these funds into a new pension, you will lose this right.
The main benefit of consolidating your other pension holdings into a SIPP is that you have all your holdings on one platform, which is easy to monitor and make changes to, while gaining access to a wide range of investment options at low cost.
It is currently difficult to put protected rights money - the fund you build up from rebated national insurance contributions when you opt out of the state second pension - into a SIPP. However, it is expected that the government will allow protected rights money to be invested in any SIPP from October 2008. The government is currently consulting on this.
Currently, protected rights money may only be invested in a small number of SIPPs offered by insurance companies, and usually at a higher cost.
But while SIPPs are becoming even more flexible and costs are certainly coming down, it's worth stressing that they aren't for everyone. If you don't have the desire to really get involved in running your pension and aren't likely to make the most of the wider range of investment choice, a standard personal or stakeholder pension is likely to be a better, more straightforward option.
A form of money purchase defined contribution pension launched by the then Labour government in April 2001 with low charges and no-frills minimum standards. Designed to appeal to people on low and middle incomes who wanted to save for retirement but for whom existing pension arrangements were either too expensive or unsuitable, the stakeholder didn’t really take off and looks to be superceded by the National Employee Savings Trust (NEST).
Allows you to bet, or take a position, on whatever you think a financial market will do next. The more the market moves in your favour (up or down), the more you profit, with unlimited potential. Similarly with losses, if the market moves against you. A spread betting company will offer a quoted “spread” on an index, share or even elements of a sporting fixture. If you think a market is set to rise, you ‘buy’ at the top end of the quote (the offer price), or if you think the market will fall you ‘sell’ at the bottom of the quote (the bid price). All gains are tax-free but you will have to deposit money with the spread betting company to cover any losses and if your losses exceed that, the company will demand more money to cover your loss-making position. Spread betting is risky; it’s for people who know what they’re doing rather than for novices.
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
Personal pension plan
A money purchase (defined contribution) pension that the holder can make contributions to if the company they work for does not provide an occupational or final salary scheme they can join or they are self-employed. PPP contributions qualify for tax relief.
Final salary pension
A defined benefit pension scheme is one where the payout is based on contributions made and the length of service of the employee. A typical scheme would offer to pay one-60th (0.0168%) of final salary (the one you’re earning when you finally retire) for each year of contributions to the scheme (even though these years were probably paid at a lower salary). Someone retiring on a final salary of £30,000 who had been a member of the scheme for 25 years would receive a pension of 42% of their final salary (£12,300 a year before tax). Sadly, many companies are winding up their final salary schemes or closing them altogether, meaning pension benefits accrued after a certain date (or those available to new employees) may be on a less generous money purchase basis.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
Open-ended investment companies are hybrid investment funds that have some of the features of an investment trust and some of a unit trust. Like an investment trust, an Oeic issues shares but, unlike an investment trust which has a fixed number of shares in issue, like a unit trust, the fund manager of an Oeic can create and redeem (buy back and cancel) shares subject to demand, so new shares are created for investors who want to buy and the Oeic buys back shares from investors who want to sell. Also, Oeic pricing is easier to understand than unit trusts as Oeics only have one price to buy or sell (unit trusts have one price to buy the unit and another lower price when selling it back to the fund).
Alternative Investment Market
AIM is the London Stock Exchange’s international market for smaller companies. Since its launch in 1995, 2,200 companies have raised almost £24 billion listing on AIM. The market has a more flexible regulatory system than the main market and can offer tax advantages to investors but its constituents are a riskier investment than bigger companies listed on the main market.