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Unleash your pension

Created:
6 October 2006

Rather than enduring mediocre performance from a managed personal pension, it may be worth taking control of your retirement funds using a self-invested personal pension (Sipp). The Sipp market is now open to all investors, thanks to a combination of rule changes since April and falling costs from Sipp providers.

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However, you need to consider your options carefully before you move into a Sipp, as some existing benefits could be lost. What's more, choosing a low-cost Sipp might not be the best option, as more expensive wrappers could offer greater flexibility - not to mention the economies of scale for large-scale portfolios.

Investment freedomUntil recently, retirement saving options were fairly limited for most investors.

You could not have a personal pension if you were already invested in a company pension scheme (unless you were a doctor). But if you were without a company scheme, you were left with personal pension funds managed by life assurance companies, whose performance has tended to be underwhelming. Sipps were an option, but high fixed charges - typically around £500 initially and annually - deterred the majority of investors.

Since April, though, it has been possible to have both a company scheme and a personal pension. The removal of age-related investment limits also enables investors to boost their contributions, paying in up to 100 per cent of their annual income (capped at £215,000).

At the same time, the Sipp market has broadened out with the advent of low-cost Sipps, some of which have no set-up or annual management charges. This makes Sipps an attractive, viable alternative to the limited offerings from personal pension providers.

As our downloadable table of popular Sipp fund choices shows, you can pick funds that have far superior performance records to the basic pension funds that are available. So you can build diversified portfolios through Sipps, holding a full range of specialist funds.

Click here to download a table of top-selling and low-cost Sipps (as a PDF file)

Of course, you should not abandon company schemes where there is a contribution from your employer. Now, though, you can make additional savings through a Sipp, rather than the limited offerings that were possible through employers' additional voluntary contribution schemes. One option, therefore, would be to use your company scheme as a core holding, as it will tend to have a conservative approach, and then use your Sipp to spice up your pension portfolio with more exotic funds.

Salary-scheme returnsYou can also transfer old money-purchase schemes from former employers into Sipps, as there are no further contributions to be lost. Final-salary schemes, however, offer semi-guaranteed returns so they should not be given up - or transferred - lightly.

That said, even those in current final-salary pension schemes may be concerned that the government's Pension Protection Fund only offers compensation up to a maximum of £25,000 a year.

As a result, high earners working for companies with solvency problems might consider diversifying some of their risk into a Sipp - especially if they had been considering topping up their contributions by buying extra years in their final-salary scheme.

Patrick Connolly, of independent financial adviser (IFA) Towry law JS&P, warns: "There may well be people who are nervous about their schemes' ability to pay out their pensions. It's a very difficult question to answer."

Remember also that the Stakeholder pension rules allow contributions to be made on behalf of non-earners - normally children or grandchildren - up to £3,600 a year (topped up by tax relief). So, rather than investing in a simple personal pension, you could start a relatively sophisticated portfolio for a child using a low-cost Sipp. This would build up a retirement pot for them (with the security that they could not squander it on youthful excess, as pensions cannot be accessed until the age of 55 from 2010) and would encouage them to take an interest in investment from an early age.

Weighing up the optionsUnfortunately, if you have transferred out of the second state pension into a personal pension fund, you cannot transfer that money into a Sipp.

But if you do have a personal pension, it is now possible to take income drawdown (now known as 'unsecured pensions') from it. Until April, these personal pensions had to be transferred into Sipps to allow drawdown.

Before taking the plunge into the world of Sipps, though, you need to weigh up the costs and the benefits.

First, those with existing personal pensions should make sure they would not be giving up useful benefits or facing high exit costs. Malcolm Cuthbert, of Sipp provider Killik & Co, notes: "We're being very careful not to recommend transfers, if it's not in the interests of the client - but for many it makes complete sense."

Exit penalties on old schemes can be punitive and could outweigh the possibility of improved investment returns from a Sipp, especially if you are close to retirement. For example, some old personal pensions have exit charges of up to 10 per cent, while 'market value adjusters' on with-profits pensions can be as high as 30 per cent.

Pension-plan benefitsYou also have to bear in mind the benefits locked-in to some older pension plans. Mr Cuthbert points to guaranteed annuity rates on old personal pensions of 12 per cent for a 60-year-old woman, compared with the normal open market annuity rate of 4 or 5 per cent. In a nutshell, you should take independent advice before switching.

Charges are also an issue, as personal pension funds may be cheaper than the funds you can buy through a Sipp. Matthew Woodbridge, of IFA Chelsea, points out: "If you want to have Neil Woodford [star manger of Invesco Perpetual's Income and High Income funds] running your pension money then, obviously, you need to pay a bit more for it."

Even so, personal pension charges have also been rising since the government lifted the cap on Stakeholder funds to 1.5 per cent a year. And, you can now buy very low-cost funds through a Sipp or buy and hold shares. For example, Sipp provider Hargreaves Lansdown charges 0.5 per cent a year to hold funds or other assets which do not pay trail commission, but this fee is capped at £200 a year.

But Sipps may not be affordable if you can only afford to make very small pension contributions - for example, Hargreaves Landsown requires a minimum lump sum of £1,000 or a monthly contribution of £50. By contrast, personal pension providers typically accept as little as £20 a month and Virgin accepts just £1 (but you are limited to a choice of two funds).

Fund restrictionsIf Sipps do appeal, though, you need to decide how flexible you would like to be. Some providers set restrictions on the funds you can pick, rather defeating the purpose of a Sipp - these are normally Sipps run by fund managers.

Most investors are likely to be happy using funds and shares, but you may not be able to hold assets such as direct commercial property in some low-cost Sipps. For example, Hargreaves Lansdown does not allow direct commercial property or traded endowments but you can hold virtually all other eligible Sipp investments, including covered warrants and hedge funds.

You should also double-check the charges before picking a Sipp provider, not least because many charge exit fees for transferring out. There may be hidden charges behind the headline figures. Alternatively, low administration costs could be offset by dealing charges - you need to consider how much trading you are likely to do.

Finally, wealthier investors should not dismiss Sipps with higher charges as a flat-rate fee can work out well in the long term. After all, a £500 annual Sipp charge only amounts to 0.5 per cent of a £100,000 portfolio or 0.05 per cent of a £1m portfolio.

Click here to download a table of top-selling and low-cost Sipps (as a PDF file)

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