You might often read or hear about SIPP style pensions in the financial press but what are they and do you need one?
What is a SIPP?
SIPP stands for Self Invested Personal Pension which, kind of does what it says on the tin: it’s a personal pension for people who want to self invest. But let’s break that down so it is easier to understand:
A personal pension is the type of pension scheme that you will have if you aren’t a member of a company final salary (also known as a defined benefit) pension scheme. Final salary pensions are the gold-plated ones that offer a guaranteed income in retirement and are linked to how long you worked for a company and what your earnings were at the point of leaving.
Even if your pension is provided through your company, if you and your company’s pension contributions are being invested in a range of funds it is likely to be a personal pension (another term for them is a defined contribution pension). The point is that you are accruing a pension fund in your name that will be used to provide an income in retirement. The key difference between a personal pension and a final salary pension is that the investment risk, costs and retirement income decision is borne by you, not your company.
The self-invested part of a Self Invested Personal Pension may still need clarifying. Most personal pensions offer a limited choice of investment options, there will be a range of funds across the major asset classes (cash, equities, fixed interest and commercial property plus sometimes commodities) and the depth and breadth of that range will vary according to the pension provider. Older pensions may only have a dozen or so to choose from, modern ones may have a few thousand.
Investing in Anything (in theory)
Where SIPPs are concerned the investment options tend to be unlimited. As long as it is available to UK investors most SIPP providers may make the investment available. This will include a broad range of unit trusts, investment trusts and any share listed on a major index: if you want to own Facebook, Apple, Alphabet, Netflix or Google shares directly, let alone any UK listed share, you should be able to.
What is more, in theory, private company shares and more esoteric unregulated investments can be held within a SIPP. So, if you are the owner of a private limited company or you want to invest in Mexican golf resorts, Amazonian teak forests or Dubai car parks you can (in theory).
In practice, however, this may be harder. Firstly because most SIPP providers, who are in effect the owner of the investment and trustees of the pension, get very nervous about investing in high-risk investments so many don’t permit them.
More importantly, if you are thinking about investing in (or have been advised to invest in) any esoteric investment I recommend you think very seriously about doing so. Unregulated investments (referred to a UCIS funds) are highly speculative and don’t offer any of the protections that FCA regulated funds do, particularly in respect of having access to the Financial Services Compensation Scheme (FSCS) and the Financial Ombudsman Service (FOS) should you wish to make a claim against the investment advice in the future.
Using Your Business Premises
Where SIPPs (and their cousin the SSAS, Small Self Administered Schemes) are attractive to many, particularly business owners, is the opportunity to invest in commercial property. This can be done directly (as opposed to via a fund of commercial properties) and SIPPs and SSASs also provide the ability to borrow within them to fund the purchase of a property.
There are specific rules surrounding the types of property that are permissible investments and about how much can be borrowed but the purchase of an office, warehouse, surgery or similar commercial premise can make very practical sense for a business owner planning for their retirement. Particularly when rental income can be charged to the business and paid into their pension.
Gordon Brown’s Bright Idea
Part of the reason that the financial media seem to be so focussed on SIPPs is that it was nearly very attractive to have one. Back in 2005, ahead of a major shake-up in pension legislation known as ‘Pensions Simplification’ (which proved to be an oxymoron), it was expected that SIPP investors would be able to invest in a much broader range of investment opportunities, most notably holiday homes, buy-to-let property, fine wines and vintage cars).
Oh, how the media, advisers and their clients salivated at the prospect of getting tax relief on a rental property or that classic car that was always dreamt of. That is until Gordon Brown, who was then the Chancellor, realised how much tax relief would be paid and income and capital gains tax lost on such largesse. So he made a U-turn shortly before the legislation was introduced.
But it still seems that the idea of a SIPP has stayed in the consciousness of the media and much of the public alike.
So Do You Need a SIPP?
If you think about what a pension is for: to provide an income to support your desired lifestyle in retirement, it is one of the most tax efficient means of achieving that objective:
- Tax relief is provided by HMRC for contributions: 20% automatically and up to 45% for high and additional rate taxpayers via self-assessment,
- the fund grows free of tax and at the point of retirement, a tax-free lump sum is available with any income generated liable to income tax.
- What is more, at present, the value of a pension fund is outside of the owner’s estate for inheritance tax purposes.
But what about the additional flexibility of a Self Invested Personal Pension?
For anyone wanting to invest in a commercial property a SIPP is certainly attractive from a tax saving point of view but from an investment perspective does it make sense? In the majority of cases, any property that is held within a SIPP will constitute the lion’s share of the value, making it a very concentrated portfolio. The owner’s retirement income is predicated on the returns of a single asset, in a single region, in a single country.
Even if the risk of loss isn’t high, the opportunity cost of missing out on the returns of a portfolio invested in a mix of assets invested globally is likely to be high. There are also much higher administrative costs associated with property investments within SIPPs.
Let’s also consider those pension savers who want to take a more active role in managing their portfolio. For them the ability to buy and sell shares and exchange-traded funds (ETFs) is attractive. I would always countenance against playing tinker man with your pension for the same reason cited above: if you are going to be reliant on the pension to provide a regular and reliable source of income that enables you to live your ideal lifestyle without money worries and maintain your dignity for the rest of your life a more patient and disciplined approach is far more prudent. As I have written about previously, investing in shares directly is a loser’s game as is the propensity to try to call the future direction of the stock markets.
In short, investing in a SIPP can be of benefit but for most people, the sensible approach is to save in a personal pension that provides access to a broad range of low-cost investment funds that are held for the long-term.
If you want to discuss your pension saving requirements contact us: www.neliganfinancial.co.uk/contact.