When the rules governing self-invested personal pensions (Sipps) change next year, the world of pensions will alter dramatically. As of ‘A-Day’, 6 April 2006, you will be allowed to hold all manner of alternative investments in your pension – including residential property, wine, art and yachts. But while buying a holiday home at a 40% discount may sound irresistible, investors should tread carefully. Remember that much of the up-front tax relief will be clawed back when you come to draw your pension and there are no guarantees that property prices will be high when you want to retire.
What are Sipps?
Sipps are the most flexible form of pension available and give you direct control over your investments instead of handing them to a pension-fund manager. Should you not wish to make your own investment decisions, you can delegate responsibility to an investment manager on an advisory or discretionary basis (the latter lets your manager take decisions without consulting you). Sipps mean you can choose from a wider range of investments. There are currently 69 Sipp providers, ranging from the big insurers such as Standard Life to small specialists. Sipps used to be more expensive than other pensions because they are more complicated to set up and run, but their growing popularity (there are now 120,000 Sipps worth around £25bn in total) means there are products for every investor, from low-cost online Sipps, which cost around £100 to set up, to top-of-the range bespoke deals.
How do they work?
As of A-Day, you will be allowed to run a Sipp alongside any occupational pension scheme. So far, the only exception to this rule will be for people earning less than £30,000 a year who are controlling directors. The arrival of A-Day will not, however, mean that you can instantly transfer your whole personal pension scheme into a Sipp. If you have protected rights within your pension funds – and millions of employees do – you will not be able to transfer the full value of your fund, says Paula Hawkins in The Times. This may change as the financial services industry is putting pressure on the Government over the issue.
What are the charges?
Charges differ widely. A growing number of Sipp providers are waiving set-up fees, but you could pay anything from £200 to £750, while annual administration fees vary from nothing to £1,000 plus. Transaction fees may be as high as £50 and are sometimes charged by the Sipp provider, even when clients have already paid an investment manager or stockbroker to carry out a transaction. The cheapest online Sipps are likely to be limited and may not, for instance, allow you to invest directly in property.
How much can I contribute?
Each year you will be able to contribute up to £215,000 or your entire salary, whichever is the lower, to a pension plan. The lifetime limit for contributions will be £1.5m in the next tax year. As of A-Day, it will also be possible to take 25% of your pension fund tax-free without being forced to draw an income from the rest of your fund (see below).
Are there any downsides?
Aside from the usual caveats about pensions (you get tax relief now, but lose control of the money until you retire, and much of it will be clawed back by the Government), there are risks. Although underlying investments in a Sipp that are regulated products, such as unit trusts, will be covered by the Financial Services Compensation Scheme, Sipps themselves are currently an unregulated product. This has raised concerns that people with many years of saving in a comparatively safe personal pension will be convinced to transfer everything they can to a Sipp sold by an unscrupulous salesman.
It is likely that Sipps will be brought under the regulatory eye of the Financial Services Authority in due course, but for a year at least, says The Daily Telegraph, there is nothing to stop double-glazing salesmen from turning their hand to promoting property-based Sipps.
Managing your own investments can be risky. If, for instance, you fail to diversify and sink your entire Sipp into a buy-to-let property, you may find yourself in hot water when you need to sell and can’t find anyone willing to pay the right price. To find an independent financial adviser who can advise you on Sipps, see www. unbiased.co.uk, or call 0800-085 3250.
A way to double your money
When contribution rules are relaxed after A-day, and investors no longer have to draw an income to receive 25% of their pension-fund tax-free, a scheme known as immediate vesting is likely to become very popular, says Debbie Harrison in the FT. It works as follows.
An investor pays a single pension contribution of, say, £78,000, into a Sipp. He will qualify for immediate basic-rate income-tax relief on the investment, which gives a fund value of £100,000. Anyone over 55 will then be able to ‘vest’ this £100,000 immediately (vesting is taking benefits in the form of cash and income), which will give them £25,000 cash in hand.
As a higher-rate taxpayer, they can claim higher-rate tax relief on the original £78,000 through their self-assessment form, which will knock £18,000 off their tax bill. This means their original £78,000 investment would have cost them just £35,000. At this point, the individual could then reinvest the £25,000 tax-free cash (TFC) and repeat the process, gaining a second slice of tax relief and another tax-free lump sump. After four transactions, they would have doubled their money. At the moment, this scheme appears to be catch-free, but it could be controversial if it proves popular next year.