Why it can pay to put all your eggs in one basket

A self-invested personal pension (SIPP) differs from a traditional pension plan in that it gives you greater control over the investments in your fund and a broader range of choices.

SIPPs can invest in the full range of unit trusts, investment trusts, company shares, gilts and bonds, overseas investments, traded endowments and commercial property such as business premises.

This can be an enormous advantage if you manage to pick good investments. However, there are some drawbacks to SIPPs, such as high costs if you pick the wrong plan.

The SIPP's facility to invest in top funds, rather than just standard funds run by the insurance companies, could make a huge difference to the size of your pension pot.

The pension funds of well known insurance companies and banks, such as Clerical Medical, Standard Life, Friends Provident and Lloyds, regularly appear near the bottom of the performance tables and have even failed to keep pace with the markets, as a cheap tracker fund would.

Funds on offer

The fund choice offered by a SIPP, compared with a personal pension or even low-cost stakeholder plan, is not as superior as it once was, as most personal pensions are no longer limited to the provider's own funds.

So you need to look at the fund range available in each case. Legal & General's stakeholder plan, for example, offers access to 40 externally managed funds. However, a SIPP still offers you access to a wider range of funds.

The other notable attraction of SIPPs is that you can invest in commercial property. This may be particularly attractive for business owners, who can part-finance the purchase of premises by borrowing against their pension fund.

It puts the property into a tax-free environment. There is no capital gains tax liability when it is sold and, in the meantime, the fund is boosted by untaxed rental income.

However, most of your retirement pot will be tied up in one asset, and the property market could be in the doldrums when you try to sell. A property can't be sold overnight, so you will have to plan well ahead if you want to take tax-free cash from your SIPP at retirement.

High charges

The big drawback with SIPPs is that their charges can be high. But they vary a lot depending largely on what kinds of non-fund investments are held. You will pay much more for a SIPP that allows commercial property, so this is important to check.

Charges also depend on whether you manage the investments yourself or appoint an adviser to advise you or manage your investments for you. Many advisers say SIPPs are unlikely to be cost-effective for funds of less than £100,000.

A full-blown commercial property SIPP will usually impose a set-up fee of around £300, an annual administration charge of between £450 and £500, fund management and dealing charges each time you buy and sell an investment, transfer fees if you move money into or out of the plan and ad hoc fees such as bank charges.

You will probably be paid paltry interest rates on any cash balance, which means that in real terms you'll be losing money in even a mildly inflationary environment.

Should you get an IFA to manage your SIPP?

A financial adviser will also charge professional fees. These will normally be in the range of £500 to £1,000 per year. However, they can add up to thousands of pounds for larger portfolios.

The Financial Services Authority has warned that some people have been given the hard sell on SIPPs when a simple low-cost stakeholder or personal pension would be more suitable.

SIPP specialist Suffolk Life charges £300 to set up a plan, £490 a year to administer the first tranche and an additional £240 per year where protected rights benefits (that portion paid in lieu of state benefits) are held separately.

As with most providers, charges for a list of ad hoc expenses run to two pages.

Low-cost SIPPs

Low-cost plans don't normally charge for setting it up or impose an annual charge for the SIPP wrapper.

But you will pay an initial charge and an annual management charge on the underlying investment funds, and dealing costs if you want to buy and sell shares. Most SIPP providers negotiate significant discounts on fund charges, which helps to bring these costs down.

Four of the best online SIPPs you can manage yourself at a significantly lower cost than a full SIPP are the Vantage SIPP from Hargreaves Lansdown, SIPPdeal's e-SIPP, Fidelity's pension plan and James Hay's eSIPP.

The Vantage SIPP from Hargreaves Lansdown and SIPPdeal's e-SIPP do not charge a set-up or annual administration charge, and offer more than 2,000 investment funds with discounts on the initial charge and reductions on the fund's annual management charge.

Dealing charges for quoted investments can be high though. The minimum contribution is just £50 a month or £1,000 a year.

The Vantage SIPP is attractive if you will be primarily investing in funds, as its fund discounts are better. But on the other hand, Vantage is less appealing for other types of investment because it levies an annual charge of 0.5% on those, up to a maximum of £200 a year.

Interactive Investor's SIPP, Alliance Trust Savings' Select SIPP and James Hay's eSIPP are good choices for investors primarily interested in trading shares and investment trusts because they charge fixed dealing costs of just £10, £12.50 and £14 respectively, irrespective of the size of the trade.

However, Alliance and Interactive impose an annual fee of £75, while the James Hay's eSIPP is limited to quoted stocks and funds only and insists on a minimum investment of £250 a month. Fidelity's plan is similarly good value, but the lite version is funds-only.

The best value full SIPPs for investing in commercial property include I.P.M SIPP Administration, which does not levy a set-up fee, but makes an annual charge of £540 plus £350 per property investment, or £700 if a mortgage is involved, and European Pensions Management, which charges a £150 set-up fee and a £350 annual management charge.

Wensley-Mackay and Skandia also offer attractive full SIPPs, while ODL Securities offers a plan fully geared to futures and options trading.

Will investing in a SIPP equal higher returns?

On average, if you compare the results of investing £100,000 in various pension wrappers over 20 years, a higher- charging full SIPP will produce an eventual pension pot of just 80% of the value of a standard stakeholder pension, based on a hypothetical investment return of 7% a year. The difference would be more pronounced for smaller pots.

However, a low-charging execution-only SIPP would produce a fund equivalent to 98% of the stakeholder pot if the returns were equal.

This could easily be turned into a larger fund than the stakeholder pot through good investment selection. So much depends on the success of the investment strategy.

SIPP basics

  • Contributions attract tax relief, so if you are a basic-rate taxpayer and invest £800, the government will add £200.
  • Higher-rate tax relief is also available on earnings of up to £150,000 per year. But from April 2011, tax relief will be reduced on a sliding scale, from 50% on earnings of £150,000 to the basic rate of 20% on earnings of £180,000 a year or more.
  • You can contribute up to 100% of your annual earnings before tax up to a limit of £245,000 for the 2009-2010 tax year or £255,000 thereafter – any more will attract a 40% tax penalty.
  • Non-earners can contribute up to £3,600 per tax year to a SIPP and still receive basic-rate tax relief.
  • If you die before you begin taking benefits from your pension, the funds will normally be passed to your spouse or beneficiaries free of inheritance tax.
  • A SIPP can be used to consolidate several different pension schemes into one plan.

This article was originally published in MoneyObserver - Moneywise's sister publication - in April 2010

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The charges listed for the Suffolk Life MasterSIPP are incorrect. There is no additional £240 per annum fee for protected rights, as these funds are all pooled together.