If you want a flexible and straightforward way to save for your retirement that puts you in the driving seat, a self-invested personal pension, or SIPP, might be appropriate. Here, we explain how SIPPs work so that you can consider whether it could be the right pension plan for you.
What is a SIPP?
A SIPP is a type of personal pension that gives you the freedom to choose and manage your own investments, allowing you to make decisions that determine how your pension pot performs. A SIPP acts as a wrapper that can hold a number of different investments and is invested until you want to make withdrawals when you retire.
Anyone under the age of the 75 who is a UK resident can have a SIPP. You can also choose to transfer in existing pensions, but it’s important to check whether you will be charged transfer fees for doing so. If the fees are high, it’s generally best to leave your existing pensions where they are.
What are the tax benefits?
SIPPs work in a similar way to other types of pension in that you can pay into them whenever you want and they enjoy the same generous tax perks. This means that for every contribution you make, the government will pay 20%. So, if you paid in £100, this would effectively be topped up to £120. This basic-rate tax relief is added to your pension automatically as your provider will claim it for you from the government.
Higher-rate taxpayers (40%) can claim up to a further 20% in tax relief through their tax return, while additional-rate taxpayers (45%) can claim up to a further 25%.
Are there any limits on SIPP contributions?
You can pay as much as you like into your pension, but there is a limit on the amount of tax relief you can claim. Most people get tax relief on pension contributions up to 100% of their salary each tax year, capped at the Annual Allowance of £40,000 (for the 2020/21 tax year). This limit includes the total value of all contributions, including those from your employer and the addition of basic-rate tax relief.
If you do not earn enough to pay Income Tax, you can pay a maximum of £2,880 a year into your pension and still benefit from basic-rate tax relief, which boosts your total contribution to £3,600 per tax year.
Once you have used up the current year’s Annual Allowance, you may be able to carry over unused allowances from the past three years, providing you were a pension scheme member during those years and your total contribution does not exceed 100% of your current year’s earnings.
A Tapered Annual Allowance was introduced in 2016-17 which currently applies for individuals with a ‘threshold income’ of over £200,000 and ‘adjusted income’ of over £240,000.
The Lifetime Allowance also limits the amount you can hold across all your pension funds without having to pay tax when you make withdrawals. For the 2020/21 tax year, this limit is £1,073,100.
Why should I choose a SIPP over other pension arrangements?
The biggest benefit of a SIPP is that, unlike other pension plans, you can choose from a much wider range of investments, which could have significant growth potential. You can also have complete flexibility and control over your investment portfolio.
In addition, SIPPs are portable, so if you change your job or stop working you can continue to contribute to your pension. If you have a new employer, they can decide to make contributions too.
However, with this flexibility comes responsibility so it’s important to research your options carefully and make sure you are comfortable making your own retirement decisions. The value of your investments can go down as well as up which means you could get back less than you put in.
What types of investment can I have?
With a SIPP, you can invest in a wide range of assets, such as:
- Stocks and shares
- Unit trusts
- Open ended investment companies (OEICs)
- UK government bonds
- Gilts and bonds
- Exchange traded funds (ETFs)
- Offshore funds
- Commercial property
SIPPs allow you to pick your own individual investments or choose a ready-made portfolio based on your investment goals and attitude to risk. By picking your own investments, it’s important to ensure you spread risk by choosing a variety of investments across a range of assets, regions and sectors.
How can I take money out of my SIPP?
You can usually start to take money from your pension from the age of 55 (rising to 57 in 2028). You can take up to 25% of your pension pot tax-free and you’ll be taxed on the remainder as if it were income. You can choose to receive your tax-free cash as a single lump sum or in stages.
You can take money from a SIPP in three main ways and you can choose just one option or a combination:
- An annuity: This pays a guaranteed income for life and you can choose whether your income remains the same throughout your retirement, increases by a fixed percentage each year or increases with inflation.
- Drawdown: This enables you to take your tax-free cash and leave the rest of your pension invested. You can make further withdrawals as and when you need to.
- Lump sum: Known as Uncrystallised Funds Pension Lumps Sums (UFPLS), this allows you to take money directly from your SIPP without choosing drawdown. Every time you do so, 25% is usually tax-free and the rest is taxed as income.
How we can help
SIPPs give you much greater flexibility than other types of pension, but they won’t be suitable for everyone. If you’re not sure whether a SIPP is right for you, our expert pension advisers are on hand to discuss your options and help you make the right investment choices.
They will assess important factors such as your attitude to risk, investment perspective and tax position to help you make the best retirement decisions for you. Why not get in touch today?
This material is intended to be for information purposes only and is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Past performance is not a reliable indicator of future returns and all investments involve risks including the risk of possible loss of capital. Some information quoted was obtained from external sources we consider to be reliable.
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