What is a SIPP? Read our Complete Guide to Find out
SIPP stands for “self-invested personal pension.” SIPPs are one of the several models of personal pension plans or schemes (PPPs or PPSs) that offer citizens of the United Kingdom a tax-privileged way to build retirement benefits.
The investment model was established by the UK government in 1989, with the first SIPPs created in 1990. Fourteen years later, the government passed the Finance Act 2004 to simplify pension schemes for individual investors, with more major changes added in 2015 with the implementation of the new Pension Freedom policies.
There are many benefits of SIPPs over other types of investment plans. Most significantly, they allow investors to have direct knowledge of where their investments are and what costs will be over time, as well as giving them access to their funds in various models. SIPPs are generally operated and maintained exclusively online, which allows investors to see their portfolio in real-time and make financial decisions from their home computer. While some providers offer mail management options, these may incur added fees.
Investors have the freedom to choose where to invest, a process known as execution-only investments. This differentiates SIPPs from more traditional pension plans that provide a limited list of choices offered by the pension provider. For this reason, SIPPs may be better suited for those individuals who have a bit more experience with investing and a deeper understanding of the market, since their added freedom comes with increased responsibility for planning portfolios, selecting investments, and managing assets. Unlike employer pensions, SIPPs are created by individuals seeking to have more direct control over their own retirement funds, and these pensions are funded solely by the investor who creates them.
The Different Types of SIPP
There are four kinds of SIPPs, each with their own rules for investors and models of operation, benefits, and drawbacks. This article contains a brief breakdown of these four plan types and an explanation of some of the different benefits of each.
Pure or Full SIPPs allow the investor complete access to the various asset classes available. This means that Full SIPPs offer the widest range of investment choices, including commercial property. Providers will often offer the advice of an investment team to help you choose the right move for your financial situation. Because of these additional services, Full SIPPs usually have higher fees associated with them than other types of investment plans.
Lite/Single Investment SIPPs
Lite or Single SIPPs are investments in what is usually a single asset. These are often able to be transferred to a Full SIPP in the future if you decide that it will better suit your plans and finances. However, be sure to check the details of the plan to make sure that this is the case, as plans can vary in allowances.
In a deferred model, the majority or even all of the assets are usually maintained in insured funds. Investor activities, such as withdrawals, are deferred until a predetermined date. In recent years, there has been a diversification of deferred plans, allowing investors more freedom to choose from hundreds of various funds options.
As the name implies, Hybrid SIPPs allow for a mix of self-invested and insured funds in an asset. Many major investment providers offer Hybrid SIPPs.
How Do SIPPs work?
SIPPs grow from investments by the individual who holds the account, as opposed to work-based pensions that involve employer funds. SIPPs investments are known as wrap accounts; this means that they allow for tax rebates. Wrap accounts provide benefits to investors, such as limiting dealings to only one counterparty and allowing investors to choose from various assets and range funds, as well as accessing plans online to more easily follow the development of their assets.
SIPP assets can include commercial property as well as trusts, exchange-traded funds, OEICs, bonds and gilt-edged securities, and cash. Currently, SIPPs can reach £1 million in a lifetime tax-free, giving a wide amount of range for growth for individuals looking for a smart way to save while avoiding penalties up front.
Some business owners will personally purchase a commercial property as part of their SIPP and then rent the property to their own company, building tax-free cash within their SIPP.
SIPPs can be started from zero or opened with transferred funds from another type of pension account, giving investors the option to begin making monthly contributions or move a sum of existing money into their new fund. While SIPP investors own their assets, they share control of them with their plan’s provider. This differentiates SIPPs from other types of investment plans. The provider’s task is to maintain tax regulation compliance.
As of 2015, once you reach the age of 55, you are free to withdraw from your pension at any time (although many people will want to wait longer to allow time for their assets to grow until they retire). Those over the age of 55 also have other options for deciding what to do with their pensions, which will be outlined below.
Withdrawals from SIPPs are usually tax-free up to 25 per cent of the lump sum, after which all withdrawals are counted by the government as income and taxed accordingly. In addition to this, there are limits as to how much can be invested in a SIPP in a given year. For earners, 100 per cent of total income up to £40,000 is permitted. Once income reaches £150,000, tax-free investments are reduced £1 for every £2 earned until the maximum £10,000 limit is reached. For non-earners, there is a limit of £3,600 annually to qualify for tax relief.
Because SIPP providers usually do not possess your investments themselves, it is a safe way to build a portfolio. Should a trust or operator of a fund fail, SIPPs are insured up to £50,000 (or £85,000 if the money remains within the SIPP), but it is important to check with a provider for specifics on Financial Services Compensation Scheme or FSCS protection, as the protocols are complicated. FSCS protection only goes into effect if a pension loses money because the SIPP provider fails, not if the investment itself fails or underperforms. Therefore, it is important to keep in mind that FSCS does not protect from an unwise or unprofitable investment.
In any case, it is unusual for an operator to fail, and it is not likely to be a situation investors have to navigate. Nevertheless, the existence of FSCS protective measures can give investors peace of mind, knowing that their investments are not going to disappear because of a failure on the part of their SIPP provider.
How to Make SIPPs Work for You
If you opted out of an employer pension plan or are self-employed, SIPPs may be a good retirement option for you. Keep in mind that if you did not opt out and are not self-employed, newer automatic enrolment policies mean that you probably already have one to which your employer contributes (so long as you qualify).
If you are new to investing, you may want to consider buying share-based funds over individual shares. This insulates you from more severe consequences should a particular company perform poorly. The more diversity in your assets, the more likely you are to have stability over time. Additionally, be sure to look over the specifics of the SIPP you are considering, as some plans are far more expensive than others, and charges can be seriously detrimental to your future funds. Closely review what you will be charged while investing and withdrawing funds. It is important to consider what kinds of investments you want to take on and how you will interact with them.
It is likely that you will want to leave your money in your pension until you are ready to retire. While you can withdraw money at any time after you turn 55, bear in mind that anything over 25 per cent will be taxed as income. On the other hand, some SIPPs have penalties for leaving money in too long, incentivizing withdrawal. It is important for you to thoroughly understand the SIPP you plan to start and the options providers offer, so that you can appropriately plan your investment strategies. Depending upon the pension you have and who your provider is, you will have varying fees for withdrawing lump sums (leaving the remainder).
Charges & Penalties
Various charges and penalties exist that SIPP investors need to be aware of, including annual charges for administration and shares, income drawdown charges, and exit fees. Some of these can be predetermined amounts, while others are percentages of funds. It is important to weigh these fees depending on what you want out of your pension and how often you plan to add to or take away from it. It is vital to understand these charges up front, so you do not end up paying more than you expected somewhere down the road, leaving you with less money for growing your portfolio and enjoying your retirement years.
Once you can withdraw the tax-free 25 per cent sum, you have the option of purchasing an annuity with the remaining amount, guaranteeing a stable income for the duration of your retirement. You can also purchase what is called a flexible income drawdown product, leaving you the possibility of continuing to grow your assets while giving you access to funds at your discretion. Of course, you can always choose to leave your money in the SIPP for a time in the future when you decide you need it, an option that many retirees find to be the best choice for them. It is necessary to consider what your plans are and how to best grow your portfolio to accomplish them. This requires significant planning on your part and a working knowledge of the consequences of your investment decisions.
SIPPs can also provide for your loved ones after your death. With some important exceptions, SIPPs are able to be passed down to beneficiaries without tax penalties. If you die before you turn 75, your beneficiary will be able to withdraw periodic lump sums, take assets as regular income, or withdraw the entirety; these three options will subject the SIPP to the income tax rate of the beneficiary at the time of the withdrawal. If you were to die before you turn 75, your beneficiary can withdraw the entirety of your SIPP without facing any tax penalties. Dependants are treated uniquely, in that unlike other beneficiaries, they can pick a flexible income drawdown or purchase annuities for tax-free income.
Be sure to talk to a financial adviser, who will be able to guide you through navigating the various SIPP opportunities to find the one best suited to your investment goals. Retirement investing is complicated, so it is recommended that you have a professional to assist you in understanding your options. SIPPs, like any investments, are not without risks and drawbacks, and you should fully understand all of these before investing. Once you decide on the investment that is right for you after careful consideration and research, keep in mind that one key tip that improves investment benefits is to go into investing for the long term. Treating your portfolio as a lifetime project rather than as a way to make money quickly helps insulate you from the normal fluctuations of the market.
Thankfully, nowadays there are many more options available to the individual investor, allowing for a variety of ways to build your portfolio in the way that best suits your financial needs. With the number of approved SIPP providers and programs, you are almost sure to find a pension plan that fits your vision of the future. Whatever you decide to do with our finances, make sure that you do not put off formulating a plan for the years to come. It is vital to make these important financial decisions with careful deliberation while you are still many years from retirement to ensure that you will have the money you need when you leave the workforce.