Get tax breaks by investing in a SIPP
For adventurous investors, the most wide-ranging pension to suit exotic tastes is without question a self-invested personal pension.
There are around 150 providers in the UK, all offering varying investment choice and pricing models. Low-cost SIPPs, or 'SIPP-lite', often provided by online stockbrokers or insurers, have a smaller investment range and can be indistinguishable from personal pensions, whereas full SIPPs offer everything that isn't slapped with a big tax charge by HMRC.
Taxable property is the one thing that HMRC doesn't like to see in a SIPP. Ditto residential property and tangible assets such as paintings and fine wine. Gold bullion does not fall into this category, but it must be kept in a vault.
Where taxable property is held in a SIPP, the tax charges are eye-watering. First, an unauthorised payment charge of 40% of the value of the taxable property is levied against the member.
Then there is a surcharge of a further 15% if the unauthorised payment exceeds 25% of the pension fund's assets. A 15% scheme sanction charge is also levied against the scheme administrator (recovered from the pension fund), plus further tax charges of 40% on any income, or deemed income, and 40% of any capital gain.
"Although it's only taxable property that incurs large tax charges, some SIPP providers still draw the line a yard back from what HMRC says is OK," Paul Gauntlett, senior pensions manager at Coutts & Co, comments.
"The provider can put on any constraints for their own benefit or to make their product cheaper. But a full SIPP should simply provide the trust structure and then make sure it keeps its nose clean with the Revenue."
There's nothing to stop investors from opening more than one SIPP. Younger investors may find they don't need full investment flexibility and are happy to have less choice in their SIPP, and pay less too. This means that if and when they want more options, they can open another SIPP that allows this.
Bryan Innes at wealth advisers Towry says many people do have more than one SIPP, one perhaps containing funds and then another for commercial property. And Richard Mattison, business development director at James Hay, admits that while his firm offers a 'full SIPP' many clients have a cheap SIPP too, holding stocks and funds.
In certain cases, it could be cheaper to hold different investments within different SIPPs. This could be true with a low-cost SIPP that has no annual management charge, such as SIPP deal and Hargreaves Lansdown's Vantage SIPP, and offers cheaper fund dealing than a full SIPP.
The downside is that it could become difficult to monitor more than one SIPP. "It would be complex to have several and one could easily fall off the radar," says Murray Smith, marketing and sales director at Mattioli Woods.
Greg Kingston, head of marketing at Suffolk Life, adds: "It shouldn't be forgotten that many investors use SIPPs as a means to aggregate various pension funds that they've accumulated over the years, and using more than one SIPP would be contrary to the trend."
Martin Tilley, director of sales and marketing at Dentons Pension Management, says that while a low-cost SIPP may have no annual manageement charge (AMC) for the wrapper, the funds held by the SIPP will. In that case, a low-cost SIPP holding, say, £100,000 in funds could end up more expensive than holding the funds in a full SIPP.
He explains: "The platforms in a low-cost SIPP work on the investor purchasing retail units in collective funds and typically have an AMC of 1.5%. The total annual cost for a £100,000 SIPP is therefore £1,500.
"A full SIPP however might be able to hold a stockbroking account where institutional units can be held in the same funds where the AMC is only 0.8%. Together with the SIPP providers' annual fee of, say, £400, this results in a total AMC of £1,200."
Whether you have one SIPP or three, investors will be happy to learn that the average charges for a SIPP have come down over recent years. According to financial research company Defaqto, the average set-up fee for a £50,000 investment is £235, with an average annual charge of £390. In 2006 the average set-up cost was £306.
Commercial property investments
Defaqto has also done some research with financial advisers into the most popular SIPP investments. The top three at the end of last year were unit trusts/OEICs, then cash deposits and commercial property.
Buying a fund is fairly straightforward. They can be held in a stockbroking account, fund supermarket or discretionary management account within a SIPP.
In terms of cash, the one thing to watch out for is getting a decent interest rate. Investec Bank research reveals the average interest rate on cash in a SIPP is just 0.43%, with some cash deposits returning less than 0.15%.
Many full SIPP providers try to secure the best interest rate for their clients, so this is something to look for if you're planning to have significant cash holdings. Smith says: "We look for the best deposit rates. Some SIPPs have tie-ups with banks and investors end up getting low rates."
Commercial property is where SIPPs really appeal to many investors. At Tilley's firm, around one in six new SIPPs are buying property, while James Hay has around 5,000 properties on its books.
Once bought, there is no tax on rental income, and if sold, any gains are exempt from capital gains tax.
Suffolk Life estimates that for half of all cases where a SIPP buys a property it is the SIPPholder's own business premises. In this case, the tenant (the SIPPholder's business) must pay a market rent to the SIPP. Selling business premises to a SIPP also means the company receives a nice cash injection.
To raise money to buy the property, investors are allowed to borrow up to 50% of the SIPP's net fund value. Even with this borrowing, buying a property is out of reach for most investors, so it is possible to club together to buy a property. Partners at a law firm might do this, or GPs buying their own surgery.
"It's the British way, wanting to buy your own property," remarks Gauntlett. "We've seen some of our clients buying properties at distressed values over the past year or so.
"Lawyers, accountants and medics set up their own SIPP and then buy their premises, and they like paying rent to themselves."
Mattison adds: "It's very popular for small businesses. They can buy their premises and build up their pensions at the same time."
Even if you don't know each other, or the property, investors can still buy part of a commercial property. Most full SIPPs allow property syndication, where the SIPP provider acquires the property on behalf of its clients, and then clients buy part of it.
"Our customers typically hold a modest slice of a property this way, around £5,000-25,000 each," says Smith. "We have property experts in our company who look out for opportunities."
There are plenty of pitfalls to be aware of with property purchases though, as Tilley explains: "One SIPP provider purports to allow overseas commercial property and so gets a tick in that box, but then imposes a minimum charge of £5,000 to consider one.
"Some full SIPPs will not permit partial property ownership, or joint ownership with the investor or another SIPP provider. Others insist on a property manager even if the property is let to the own member's business. Some insist that insurance is through their own block policy."
He adds: "Where VAT is applicable on joint or syndicated property transactions they can become complex and more expensive than initially thought."
Innes also warns that costs can spiral: a headline fee might be £500 to buy a property, but the annual fees could jump to £1,500. "Make sure you get advice on the total expense of setting it up, and the cost of administering it," he says.
Alternative SIPP investments
Popular property purchases aside, there are plenty of weird and wonderful things investors can stuff in their SIPP.
Smith says one client recently bought a domain name for his company through his SIPP and licensed it back. And Gauntlett had a client that wanted to buy a US non-listed private equity fund - the client's SIPP provider didn't want to do it, so Coutts set about finding a provider that would.
CFD trading is also permissible in a SIPP. However, not all SIPP providers or CFD brokers will allow it, so you will have to seek out one that does. For example, Dentons and AJ Bell do allow it but Hornbuckle Mitchell does not.
Tilley says SIPP investors must watch out for gearing though. The maximum gearing permitted in a SIPP is 50% so CFD trading must be done within these rules. If you've already borrowed to buy a property, you may not be able to do CFD trading too.
Investors can also put unregulated collective investment schemes (UCISs) in their SIPP. These can be based outside the UK and are not regulated by the Financial Services Authority. Despite the lack of regulation, they appeal to investors with exotic taste. They invest in areas such as film production and forest plantations.
Tilley says they have been popular among his clients, but numbers have dropped recently after the FSA started to take a hard line on their recommendation. As they are not regulated, companies can make bold guarantees such as 8.5% annual return, and if this doesn't materialise, investors are left with little hope of compensation.
Intellectual property rights, such as company trademarks, and enterprise investment schemes and venture capital trusts may also be held in SIPPs.
And further flexibility with SIPPs comes in the form of allowing in-specie transfers and payments (transferring the actual asset, rather than selling it and transferring the cash) and the ability to appoint the discretionary manager of your choice.
SIPPs typically offer all income options, such as phased drawdown and annuities. However, Mattison says some SIPP providers, especially insurers, don't offer flexible drawdown (which removes the need to buy an annuity, subject to a minimum income of £20,000), even though the new rules allowing it came into effect on 6 April.
Tilley explains: "SIPP providers make money from managing clients' money through retirement so there is a reluctance to allow people to remove their money all at once when they retire." James Hay, Dentons, AJ Bell and Rowanmoor pensions do offer flexible drawdown.
So how much money do you need to take out a full SIPP? Although some providers don't impose a minimum investment level, a general rule is that you need £100,000 to make it a cost-effective option, due to the flat-rate annual charges.
Tilley notes: "We operate a floor of £50,000 beneath which the economics of establishing and running a full SIPP come into question."
And finally, when choosing a SIPP, Mattison says close attention should be paid to the charging structure of the wrapper, investments and income options at retirement, as well as the flexibility: "Can you really move from property to a hedge fund easily?"
This article was taken from the May 2011 issue of Money Observer.
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.
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).
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
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.
Investors who borrow money they use for investment and use the securities they buy as collateral for the loan are said to be “gearing up” the portfolio (in the US, gearing is referred to as “leveraging”) and widely used by investment trusts. The greater the gearing as a proportion of the overall portfolio, the greater the potential for profit or loss. If markets rise in value, the investor can pay back the loan and retain the profit but if markets fall, the investor may not be able to cover the borrowing and interest costs, and will make a loss. Also used to describe the ratio of a company’s borrowing in relation to its market capitalisation and the gearing ratio measures the extent to which a company is funded by debt. A company with high gearing is more vulnerable to downturns in the business cycle because the company must continue to service its debt regardless of how bad sales are.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
A charge some brokers (and, increasingly, lenders) make for arranging your loan or mortgage, either as a flat fee or a percentage of the amount you wish to borrow. In order to look ultra-competitive in the best-buy tables, some mortgage lenders will offer mortgages with an attractive low rate and recoup any losses with a hefty arrangement fee.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
A complicated financial instrument, Contracts for difference are a specific type of derivative. They were developed to allow the capital benefits of investing in an asset without actually physically having to own or pay full price for it. A CFD is a contract between a buyer and seller, stipulating the buyer will pay to the seller the difference between the current value of an asset (share, bond, commodity, index) and its value at contract time. If the difference is negative, then the seller pays the buyer).
Annual management charge
If you put money in an investment or pension fund, you’ll not only pay a fee when you initially invest (see Allocation Rate) but also a fee every year based on a percentage of the money the fund manages on your behalf. Known as the AMC, the actual percentage varies according to the particular fund, but the industry average for active managed funds is 1.5%.