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.
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 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.
- 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
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
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.
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 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).
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
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.
Describes the relationship between a client and a stockbroker or independent financial adviser whereby the broker or adviser acts solely on the client’s instructions and doesn’t offer any advice on which shares to invest in or financial products to buy and simply “executes” the wishes of the client, regardless if they are judged to be sound or wrong. Other types of broking service offered are advisory (whereby the client/investor makes the final decisions, but the broker offers advice) and discretionary (whereby the broker manages the portfolio entirely and makes all the decisions on behalf of the client).
A type of derivative often lumped together with options, but slightly different. The original derivative was a future used by farmers to set the price of their produce in advance before they sowed the seeds so that after the harvest, crops would be sold at the pre-agreed price no matter what the movements of the market. So a future is a contract to buy or sell a fixed quantity of a particular commodity, currency or security (share, bond) for delivery at a fixed date in the future for a fixed price. At the end of a futures contract, the holder is obliged to pay or receive the difference between the price set in the contract and the market price on the expiry date, which can generate massive profits or vast losses.
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%.