Sipps: What are they and who are they for?
By Kate Saines
For many of us – particularly those who like to do the archetypal ostrich impression when it comes to our finances – knowing where our pension contributions are being invested remains a complete mystery.
After all, when we sign up to our company pension schemes all we really care about is how much it will dent our wages, how much our employer's willing to match and how much money we'll make on it.
When it comes to the real nuts and bolts – in other words, the investments the pension fund managers are investing our contributions into – we generally don't get much say.
And even if we do it's easier to delegate this to the experts.
However, the financial turmoil of late has been a huge wake-up call to anyone who has been dozing off when it comes to their finances.
A combination of high profile pension plans being squandered not to mention the poor performance of many schemes is providing a strong case for products which provide us with a bit more control in our investments.
Enter Self Invested Personal Pensions (Sipps).
The only way to describe these products is as DIY pensions because we literally create them ourselves.
It's a bit like choosing our own ingredients to make ourselves a slap-up meal instead of going out and buying a take-away.
Using this analogy, it’s clear to see there are some great benefits to Sipps, but also some large pitfalls. So we've asked two experts in Sipps to provide us with an overview of the products to help you make a decision about whether they are right for you.
What are Sipps and how do they work?
Andrew Coles, an IFA at Beard and Coles Financial Practice, sums up Sipps as a form of personal pension which gives you the freedom to chose and manage your own investments.
If you choose you can employ (and therefore pay for) an authorised investment manager to make the decisions for you.
But whether you make decisions yourself or delegate to another you'll benefit from the main principles of Sipps investing which is that you can choose from a wide range of investments – far more than in a pension or stakeholder scheme.
The choice is vast – and there is a list of the main investments at the end of this article. However, to give you a taster Neil Baker, an IFA for Protection and Investment Ltd, explains: "You can invest in almost anything via a SIPP including unquoted shares, commercial property, also things like National Savings products and traded endowment policies.
"[People] will also be able to invest in things like stamps, fine wine amongst other things on top of the usual gilts, unit trusts, deposit accounts, investment trusts and stocks and shares."
Commercial property is a classic example of an investment which would be excluded to investors through a personal pension.
Who are Sipps for?
Although anyone can take out a Sipp if they wish, they are generally suited to more experienced investors.
And they are more commonly owned by those with large amounts of money – normally over £100,000 - already within a personal pension.
They are also used by business owners as a way of purchasing their commercial property. This is because Sipps provide the ability to borrow money – from within the Sipp itself – to buy premises.
How do I start investing in Sipps?
Like personal pensions, there is no restriction on how much can be invested into a Sipp says Andrew Coles.
He added: "From April 6th tax relief is limited to £50,000 per year or 100 per cent of your income for that tax year. An unlimited amount can be invested, however this does not receive tax relief."
Investments can be made as frequently or as infrequently as you like but because there are high charges on Sipps people tend to restrict these deposits to larger investments of £100,000 and over.
Neil Baker recommends speaking to a financial adviser first, just to see whether taking out a Sipp is right for you.
He thinks, a lot of personal pensions will do the job for most people and Sipps do not suit everyone.
Before you start investing you need to consider how much money you have.
Mr Baker said £50,000 was a good starting point. This could be by way of a pension transfer or a lump sum investment.
He added: "That's not to stop someone investing with a £50 monthly contribution, but it would more than likely be more expensive than your normal personal pension."
Why invest in a Sipp?
The biggest advantage of having a Sipp is the huge range of investments which can be held inside the product. And this provides investors with more freedom.
There are, as we mentioned, advantages for businesses. Andrew Coles explained that a Sipp enables business owners to purchase business property without tying up valuable cash flow within the business.
He continued: "A Sipp enables you to borrow money as well (under strict rules) and this can be used to buy a property, allowing investors to take advantage of gearing their investment."
He warned, however, that this will also increase the risk within the portfolio.
"Sipps also provide a way of passing assets onto children without having to pay inheritance tax (IHT) on them," Mr Coles added. "A family Sipp can pass the business assets from parent to offspring without an IHT liability."
What do I need to watch out for?
The biggest problem with Sipps is the expense. They basically cost more than a personal pension and you'll pay more for a smaller pot.
Mr Coles said: "A Sipp is a 'gold plated' personal pension meaning it allows investors more flexibility to invest in specific investments – however, this comes at a price."
It's important to take advantage of the fact you can choose from the variety of investments as limiting your portfolio will expose you to more risk.
Mr Coles explained: "If purchasing a property through a Sipp, investors should ensure they retain sufficient diversity within their portfolio, as a diversified portfolio of investments can help reduce risk.
"For many investors looking to use a Sipp, holding a property may dominate the portfolio, not giving sufficient diversification."
It is also important to be aware that if a property is purchased it must also – potentially – be sold if the investor wishes to use the fund to purchase an annuity.
"Thus there is always extra risk associated with holding property in a portfolio due to the lack of liquidity associated with this asset class," said Mr Coles.
How much will it cost me?
You will pay an initial charge, which is usually between £200 and £400 and there will be an annual charge of between £300 and £600.
And there are a whole host of other possible charges. Some providers ask for a fee for transferring funds from other pensions to a Sipp, buying and selling investments, and transferring the Sipp elsewhere.
However, Andrew Coles explained that many pension providers are now offering deferred Sipps which give investors the flexibility to turn their normal personal pensions into a Sipp when they choose without incurring the charges of a full pension switch.
If you use the Sipp for a property purchase, pension trustees can charge for their services.
Neil Baker also pointed out if you seek advice from a financial adviser, they will charge the equivalent of 0.5 per cent and one per cent per year of the value of the pension fund.
What happens to the Sipp when I retire?
The process, at retirement, is much the same as with a personal pension. Sipp-holders can take a tax-free lump of 25 per cent of the pot.
There are two options for handling the rest of the money. It can either be used to buy an annuity, which will provide a set monthly income, or Sipp-holder can go into drawdown.
"Drawdown," said Neil Baker, "is where you keep the money invested in the pension, and take a set amount as income which is pre-determined by the government dependant on age.
"People may use this option to benefit from market movements or, for example, even to defer the annuity by a few years to hopefully get better terms."
How do I sign up?
It's very important to get financial advice before getting a Sipp, not only to steer you on the right course when creating your pension, but to find out if you need this product.
Finding a Sipp provider should not be too difficult as there are plenty out there.
Andrew Coles said: "Most, if not all, mainstream providers will offer Sipp products and there are also some specialist Sipp providers on the market."
If you do decide you want to start investing in Sipps, you'll not be alone. Neil Baker said Sipps are becoming more popular for investors because of the flexibility they offer at retirement.
"Being able to go into drawdown without taking an annuity is very appealing for many retirees," he said.
Andrew Coles, meanwhile, said Sipps were designed to be a niche product and this remained the case, but the flexibility provided by deferred Sipps was set to make them more accessible going forward.
He explained: "If you are currently in your thirties and making reasonable pension contributions, you may find that in ten to 15 years time, as your earnings grow, a Sipp becomes a more attractive option.
"With the Sipp being easier to access you could simply turn your current pension into a Sipp. Thus on a longer term basis, they could become more and more prevalent."
List of the main investments permitted in a Sipp
• Deposit accounts (in any currency providing they are with a UK deposit taker)
• Government securities and other fixed interest stocks
• Unit trusts
• Open ended investment companies (oeics)
• Investment trusts
• Insurance funds
• UK stocks and shares including shares listed on the Alternative Investment Market (AIM)
• Overseas stocks and shares quoted on a Recognized Stock Exchange
• Unquoted shares
• Commercial property
• Ground rents in respect of commercial property
• Traded endowment policies
• Permanent Interest Bearing Shares (PIBS)
• Warrants
• Futures and Options
Use the Myfinances.co.uk comparison tables to find the best deal on a pension or annuity.
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