In our first post in this series we looked at the tax advantages offered by Self Invested Personal Pensions (SIPPs). In this post, we'll go on to look at three more key benefits of SIPPs. These are:
- Greater choice
- Better planning
- You can open a SIPP for a child.
The greater choice offered by SIPPs
SIPPs allow you to choose where you want to invest your pension savings. Instead of being restricted to a limited range of funds – as with some other types of pension – SIPPs offer a wide range of investments to choose from. You can also decide how much you want to invest and how often. You can even transfer in pension plans from other providers.
You can typically choose from thousands of funds run by top managers, as well as pick individual shares, bonds, gilts, unit trusts, investment trusts, exchange traded funds (ETFs), cash and commercial property (but not private property).
With a SIPP you are free to invest in:
- Cash & Deposit accounts (in any currency, providing they are with a UK deposit taker)
- Insurance company funds
- UK gilts
- UK shares (including shares listed on the Alternative Investment Market)
- US and European shares (stocks and shares quoted on a recognised stock exchange)
- Unquoted shares
- Permanent Interest Bearing Shares
- Commercial property
- Ground rents in respect of commercial property
- Unit trusts
- Open ended investment companies (OEICs)
- Investment trusts
- Traded endowment policies
- Futures and options
The planning benefits of SIPPs
One of the benefits of SIPPs are the options at retirement, which can give you greater flexibility. As with other forms of pension, you can take a tax-free lump sum when you retire. There are also a number of income options to choose from, for example, you can opt for drawdown pension if you don’t want to buy an annuity.
Options at retirement
You’ll probably want to keep a certain amount of freedom with your investments when reaching retirement and a SIPP can give you more flexibility and control than other pension options. It’s also good to know that you do not have to retire from work to take benefits from your SIPP. Under current Government legislation you can begin taking benefits at any age from 55. Once you retire, a SIPP opens up several options to help you with your individual retirement needs.
Take 25% as a tax-free lump sum
Part of your pension (up to 25%) can normally be taken as a tax-free lump sum, also known as a Pension Commencement Lump Sum (PCLS). You can take a tax-free lump sum at any time from age 55, whether you then take an income from the remainder of your pension fund or not.
3 ways to take income
Whether you have taken a tax-free lump sum or not, you can draw a taxable income from your pension fund at any point from age 55. From this age you can take your benefits in stages (both income and tax-free lump sum). This is known as phased retirement. You choose how much of your current fund you use to provide benefits at each stage.
Income can be taken in the form of:
- Drawdown pension
- Annuity (secured pension)
- Combination of drawdown pension and annuity
Drawdown pension: A way to keep growing your assets
Available at any time from age 55, a drawdown pension is an alternative to buying an annuity. This is something that personally appeals to us because it allows you to keep growing your pension. With a drawdown pension, you simply take an income from your pension fund. There is no minimum withdrawal amount for income drawdown, so you could choose to withdraw zero income if you wish.
The maximum income you can draw is calculated with reference to the equivalent level single life annuity bought using the same fund. With effect from March 26th 2013 limits increased to roughly 120% of an annuity income. The limits are calculated at the start of your income drawdown plan using GAD (government actuary department) tables, which use your age and 15 year gilt yields to calculate the income available from your fund.
Flexible Drawdown will allow some individuals the opportunity to withdraw as little or as much income from their pension fund as they choose, as and when they need it. To be eligible for this, you have to declare that you are already receiving a secure pension income of at least £20,000 a year and have finished saving into pensions.
Death benefits: Another reason to consider income drawdown
When you want to start drawing your pension, it is normal to consider the financial position of any spouse or civil partner, should you die before them, as well as any dependent children. Normally, when buying an annuity, a choice must be made at the outset as to what proportion (if any) is to be paid on the annuitant’s death. This will almost always reduce the starting pension for the surviving spouse/civil partner.
When annuity rates are unusually low, as they are at the time of writing, this extra reduction on income is unwelcome. With an income drawdown pension, on death whilst drawing an income the survivor can inherit 100% of the deceased’s pension, or take a lump sum instead, less a tax charge.
This means a couple may happily enjoy the maximum income available at the outset, knowing that should the investor die, the survivor will not lose out. Of course, it is still the case that drawing income from a fund that might be falling in value, will put the fund at risk, and an investor could run out of money. So income drawdown is really only for those who are able to understand and accept this risk.
- Your pension will be exposed to the risk that investments can fall as well as rise
- When you sell your investment, you may get back less than you originally invested
- If withdrawals exceed growth, the value of your pension pot will drop
Available at any time from age 55, a lifetime annuity converts your pension fund into taxable pension income, which will be paid to you for life. They are usually provided by insurance companies. The amount of income can be either level or increasing and is guaranteed for the rest of your life once set up. Annuities therefore may suit those who are comforted by the fact that their income will never run out.
There are a number of different types of annuity available, which allow you to take into account any requirement you may have for your spouse’s pension and whether you want your income level to be linked to inflation year on year.
You should note that some annuity providers offer higher annuity rates to people who are suffering from various medical conditions or who have health limiting lifestyles. If you smoke, take medication for a medical condition, or have been hospitalised in the past five years, this may lead to a larger income from an annuity provider. You can choose to transfer out to an annuity provider of your choice using the Open Market Option (OMO).
The benefits of SIPPs for children
It’s never too early to start saving for a pension. As well as the option of investing in a Junior ISA, you can also open a SIPP for a child under 18 and get tax relief to help their retirement fund grow for longer. Many parents and grandparents use the tax benefits of SIPPs to set up pensions for their young children and grandchildren.
Did you know that less than half of Britons are actually saving for when they retire? Yes, shocking but true and yet to expect an annual retirement income of only £15,000 in today’s money, children will need to have saved the equivalent of £203,528 by the time they retire.
If you start saving at 25, this means putting aside £449 a month until the age of 65. However, thanks to the power of compounding returns, you don’t have to pay thousands of pounds a year to make a difference. Put away £39 a month for the first 18 years of a child’s life, and, with tax relief boosting the contribution to £50 a month, it would be worth £506,064 when your child reaches 65, assuming 6% annual growth.
Points to remember
- Under current legislation, you can open a SIPP on behalf of a child under the age of 18
- The Government will pay tax relief on contributions up to a maximum of £3,600 per annum, i.e. you pay £2,880 and the Government will provide £720 in tax relief
- Once the child reaches the age of 18, they can take over the management of the SIPP and make their own contributions to it, receiving tax relief in their own right.
We have covered quite a bit of ground in our last two posts on SIPPs. In case you still have questions unanswered, in next week's post we'll include a comprehensive SIPP FAQ.
As always, if you have any questions or thoughts on the points covered in this post, please leave a comment below or connect with us @ISACO_ on Twitter.
ISACO is a specialist in ISA and SIPP Investment and the pioneer of ‘Shadow Investment’, a simple way to grow your ISA and SIPP. Together with our clients, we have £57 million actively invested in ISAs and pensions*.
Our personal investment service allows you to look over our shoulder and buy into exactly the same funds as we are buying. These are investment funds that we personally own and so you can be assured that they are good quality. We are proud to say that by ‘shadowing’ us, our clients have made an annual return of 12.5% per year over the last four years** versus the FTSE 100’s 7.4%.
We currently have close to 400 carefully selected clients. Most of them have over £100,000 actively invested and the majority are DIY investors such as business owners, self-employed professionals and corporate executives. We also have clients from the financial services sector such as IFAs, wealth managers and fund managers. ISACO Ltd is authorised and regulated by the Financial Conduct Authority (FCA). Our firm reference number is 525147.
* 15th November 2012: Internal estimation of total ISA and pension assets owned by ISACO Investment Team and ISACO premium clients.
** 31st December 2008 - 31st December 2012.
ISACO investment performance verified by Independent Executives Ltd.