Taking out a self-invested personal pension (Sipp) is big step. It can potentially be hugely rewarding, but you need to be absolutely sure that's its right for you. Ultimately, you'll need to discuss your particular situation with a financial adviser and make your mind up based on careful consideration of your case. To help your thought-process, though, we've provided answers to some of the key questions about Sipps - starting with the basics and then going a bit deeper.
What is a Sipp and why might I want one?
A self-invested personal pension is just a basket for storing investments in a tax-efficient way for you to live off later on during your retirement. Crucially, with a Sipp, you decide what goes into that basket, choosing from a wide - although not unlimited - range of assets. If you make good choices, then you could end up with a much better income to live on during your retirement than you might get with other types of pension.
Am I eligible to establish a Sipp?
Very likely. Until April 2006, it wasn't possible to contribute to both a company scheme and a personal pension if you were earning more than £30,000 a year. That excluded a huge number of the people most likely to take out a Sipp. Now, however, you can participate in your employer's scheme as well as having your own personal pension pot. There's been a flood of people taking advantage of this new freedom.
Okay, but is a Sipp suitable for me?
While there are potentially many benefits to having a Sipp, it's not necessarily a suitable arrangement for everyone. But if you are quite wealthy, have a good understanding of investment, and want to select individual shares and property to put in your pension, then a Sipp may be for you.
How rich do I have to be to make it worthwhile?
The freedom to pursue your own investment strategy can come at the price of higher costs.
If you want a full Sipp, you might have to pay a flat set-up fee of several hundred pounds and ongoing administration fees after that. Given this high level of fixed costs, you need to have quite a substantial sum to start off with to justify taking out a Sipp - probably over £100,000. But if you opt for a low-cost Sipp, you will not be able to use all the available investment options.
What sort of things can go into a Sipp?
Shares, bonds, and fund investments all qualify. Derivatives such as contracts-for-difference, futures and options are okay, too. Commercial property, notably your business premises and farmland, also meet the criteria.
What about residential property?
Unfortunately not. There were high hopes that the rules would change to allow people to put their main residences, Spanish villas, French ski chalets and buy-to-let properties in Sipps, but the chancellor changed his mind and there are only a few very limited ways in which you can get any exposure to residential real estate through a Sipp. Direct investment will now incur a 55 per cent penalty tax charge, apart from certain favoured categories: student halls of residence, nursing homes, prisons and hotels.
You can also invest in residential property through funds and syndicates. Syndicates must pass several tests, though, including having at least 11 members (no member can own more than 10 per cent) and having a value of at least £1m or holding at least three properties (no one property can account for more than 40 per cent).
Will my Sipp provider let me put all these things into my Sipp?
Not necessarily. Just because an asset qualifies for a Sipp doesn't mean your provider will actually allow you to include it. Capita - administrator of the Scottish Equitable Sipp - was recently involved in a row because it refused to allow a customer to invest in an offshore fund-of-hedge funds, because of liquidity and bureaucracy issues. So, it's vital to get the sort of Sipp that meets your particular requirements. And even if a Sipp does accommodate your needs, you need to ensure that the costs are reasonable.
Do I have to allocate my money in any particular way?
No. You could stick the lot into shares of your favourite company or into a particular commercial property, if you so chose. Clearly, though, that would not be advisable. Instead, you should use a Sipp to spread your investments across other assets within the Sipp or your assets outside it.
So I'd be running the show without outside interference?
Not quite. While you will decide which assets to hold, you will have to do it through a Sipp provider. The law says that a taxman-approved trustee and administrator must oversee each Sipp to ensure that all the rules are followed. So, your provider will assist with the paperwork, claim some or all of the initial tax relief back for you, and keep track of your portfolio on your behalf.
But, administration Aside, I'd be free to do as I choose?
That would depend on what sort of Sipp you went for. The most popular option is to have an advisory Sipp, where investors get help from professionals but make the decisions themselves based on the advice they get. In a discretionary Sipp, by contrast, a wealth manager takes the decisions for the Sipp holder. However, you can also pursue your own strategy and ideas exclusively, with your provider merely carrying out your orders.
What sort of tax breaks are on offer?
Very substantial. For every pound you put into your Sipp, the government will refund tax up to your marginal rate. If you're a top-rate taxpayer - as most Sipp investors tend to be - that means the government will refund 40p in the pound on your contributions up to the annual contribution limit (£225,000 from 6 April) or 100 per cent of your earnings, whichever is lower. The Sipp itself receives basic rate (22 per cent) tax relief and you must reclaim the remainder through the self-assessment tax return. Also, your investments within the Sipp, and the income from them all, grow free of tax.
I've already got a couple of existing pensions - one from an old employer and a personal one. Can I put these towards a Sipp?
Yes. Transferring an existing personal pension is the most popular way of starting off with a Sipp. It's a logical way of bringing together the bits and bobs of pensions you may have from previous jobs, as well as other holdings. Be aware, though, that you may not be able to transfer all your benefits from either personal or corporate schemes. And it would be foolish to switch from a current occupational pension scheme, as you would forgo any future contribution from your employer. Old final-salary pensions should also be left intact, as the benefits tend to be generous and your former employer covers all the investment risk.
What could I stand to lose from transferring existing pensions then?
It is not possible to transfer the protected rights portion of your existing pensions. Protected rights are those benefits that come from contracting out of the second state pension. You will either have to leave this portion in your original scheme or move them into a traditional personal pension. There are other potential benefits you could lose or penalties payable upon transferring. This is why it is essential you take professional advice based on your own circumstances.
I've also got a portfolio of shares. Can I put them into a Sipp?
Yes. Transferring shares and other eligible assets that you already own into your Sipp is known as making an 'in specie' contribution. The monetary value of the asset you're putting is worked out and then you receive tax relief on that amount as long as it doesn't take you over your annual contribution limit. However, the transfer will incur stamp duty and could give rise to capital gains tax.
Might I be better off sticking to another type of personal pension?
Very possibly. There's no point paying high fixed charges for the extra investment freedom that Sipps can offer unless you really are going to use it.
What sort of costs are involved in having a Sipp?
Limited, low-cost Sipps are growing in number but setting up a full Sipp can typically cost several hundred pounds, and there may be an annual administration charge thereafter. Then you have to consider the cost of transactions, such as dealing charges on share and property purchases. It's therefore vital that you get a Sipp with a cost structure most suitable to your own circumstances, based on how often you deal or what you deal in.
Can I leave my Sipp to someone else when I die?
Yes. This is one of the beauties of a Sipp. As long as you haven't used your Sipp to buy an annuity and you die before the age of 75, the amount can pass to your beneficiaries. And you can leave it to anyone, not just a spouse or family members. They inherit the remaining amount as a lump sum, although they'll have to pay tax of 35 per cent on it.
Can I still leave my pension to my heirs if I live longer than 75?
The rules require you either to use your Sipp to buy an annuity or to convert it to an alternatively secured pension by the age of 75. If you want your heirs to benefit from your pension pot, you should take an unsecured income from the time of your retirement until the age of 75, after which you'd opt for the alternatively secured pension (ASP) option. Any ASP funds remaining on death can be passed to charities tax-free or left to your family - although transfers to family will be hit by a 70 per cent tax charge plus inheritance tax at 40 per cent on sums over the exempt allowance (£300,000 from 6 April).
Is there a limit on how much I could save up in total?
Yes. The standard lifetime allowance is a limit on the total value of all your pension savings. It's the amount you can save without incurring tax. It was set at £1.5m for 2006-07, £1.6m for 2007-08, and is set to rise to £1.8m by 2010-11. Increases beyond then will be decided by the Treasury. Note that these figures include other pension savings outside of your Sipp, so the value of any other of your pension schemes must be taken into account.
What happens if I go over the limit?
Funds in excess of the lifetime allowance potentially face a tax rate of up to 55 per cent. But in cases where the amount in a Sipp goes over lifetime allowance or where it is likely to, it is possible to register the funds for protection with the taxman and avoid punitive tax on the excess sum.
You can protect your lifetime limit until 5 April 2009 but enhanced (unlimited) protection would not be possible if you had made any contributions since 6 April 2006. Even so, you could still apply for primary protection, which relates your current pot size to the lifetime limit on an indexed basis.
When can I start to draw my Sipp?
The age at which you can start drawing a Sipp is 50, but that will rise to 55 from 2010 onwards. However, certain specialised careers with a short duration - professional sport, dancing, modelling - allow early access to a pension. In certain circumstances, you may be able to start drawing your pension early on the grounds of ill-health.
What's the latest I can start drawing my Sipp?
You must convert your Sipp to an annuity or an ASP by the age of 75. If you choose the latter, you keep your Sipp investments intact while drawing an income from them. When you die, your spouse or dependant can buy an annuity or draw an unsecured income until they reach 75. At that stage, it will convert back to an alternatively secured pension. Note, though, that there are numerous tax implications to be considered when taking this course of action.
How will it pay out?
You can take a tax-free lump sum at the start worth up to one-quarter of your Sipp's total value. So, for someone retiring today with the maximum amount in their Sipp, this would mean a one-time payment of £375,000. With the rest, you can either buy an annuity or keep it invested in the Sipp and draw down an income. Tax would naturally be payable on the income taken.
Who do I complain to if things go wrong?
The Financial Services Authority (FSA) will start to regulate Sipps from 6 April this year. After then, you will be able to take complaints to the FSA and seek compensation using its procedures. However, increased regulation may not be an unmitigated blessing. Complying with regulation is likely to push up providers' costs, which they will pass on to customers.
How will FSA regulation change Sipps behaviour?
Although the FSA will start to regulate Sipps from 6 April, this should make little practical difference, as investment advice is already regulated by the FSA. The FSA will crack down on misleading marketing material about Sipps and you will now have up to 30 days to cancel a Sipp contract, if you change your mind.
If you make your own investment decisions, you would not be able to claim against your Sipp provider, even if holding an ineligible asset led to a hefty penalty tax charge. However, Sipp providers can be hit by penalty tax charges of between 15 and 40 per cent of a Sipp's value, if ineligible assets are held, and repeat offenders could lose their right to operate a Sipp.
All your assets in a Sipp are ring-fenced, so you would not lose any money if your provider collapsed, unless you were the victim of fraud. If your provider could not repay you, you would be entitled to up to £48,000 compensation from the Financial Services Compensation Scheme.
If you want to make a claim against your adviser or Sipp provider, it will have eight weeks to respond before you can take your complaint on to the FSA (see www.fsa.gov.uk or call 0845 606 1234 for guidance on complaints).
1 A self-invested personal pension is just a basket for storing investments in a tax-efficient way for you to live off later on during your retirement
2 The freedom to pursue your own investment strategy comes at the price of higher costs
3 For every pound you put into your Sipp, the government will refund tax up to your marginal rate
4 Transferring an existing personal pension is the most popular way of starting off with a Sipp
5 You can go over the annual contribution limit - £225,000 for the 2007-08 tax year - but you won't get tax relief on amounts above this level
6 The age at which you can start drawing a Sipp is currently 50, but that will rise to 55 from 2010 onwards
7 You can take a tax-free lump sum at the start worth up to one-quarter of your Sipp's total value