Running your own investments is not easy, and when it comes to pensions and retirement money this is even more the case. We set out the types of investments you might hold and the mistakes to avoid when running your own self-invested personal pension (Sipp).
Choosing your investments
If you are starting a Sipp, you probably don’t have a great amount of money to invest so can’t spread it across a number of funds. And in any case, if your Sipp value is small you don’t want to incur many charges by holding a high number of investments.
But you still need to be well diversified, so a good first investment could be a global equities fund. This will give you broad geographic exposure, including to some of the world’s major markets such as the US, in one holding for one set of charges. This type of fund does not include non-equity assets, but if you have decades to go until your retirement then you need growth, and equities are one of the best ways to get it.
“If you are starting a Sipp and have a reasonable amount of time until retirement, you need to take some risk,” says Darius McDermott, managing director at Chelsea Financial Services. “I would not favour bonds as a core investment [at this stage].”
You can get passive global equities funds that track market indices such as MSCI World. These have very low charges, which is beneficial if you have a long time horizon, as over such periods charges can eat into considerable amounts of your returns. Options include HSBC MSCI World UCITS ETF (HMWO) which has an ongoing charge of 0.15 per cent.
But passive funds do not aim to outperform indices, and if there is market volatility they will follow all the ups and downs. If you would like to try to make a better return than market indices, active fund options include Rathbone Global Opportunities (GB00BH0P2M97). This is one of the best performing funds in the Investment Association (IA) Global sector, and has a good record of outperforming indices such as MSCI World and FTSE World.
As the size of your Sipp grows you could diversify it by adding some regional funds. “If you have a long-term investment horizon and can take some risk, you want something that taps into the fastest growing parts of the world, so could add some exposure to Asia and emerging markets,” says Mr McDermott.
Options include Stewart Investors Asia Pacific Leaders (GB0033874768) run by David Gait, who has a strong long-term performance record. Fidelity Emerging Markets (GB00B9SMK778) invests in emerging markets such as China, India, South Africa and Russia.
Another area for growth over the long term is smaller companies. These are typically at an earlier stage than their larger counterparts so have more potential for growth. But they can be volatile and higher risk than their larger counterparts. Ways to get exposure to them include Standard Life Investments Global Smaller Companies (GB00BBX46522), which has outperformed MSCI World Small Cap index and the IA Global sector average over three and five years.
You can find suggestions on bond funds, and more global, Asian, emerging markets and smaller companies funds in the IC Top 100 Funds and IC Top 50 ETFs.
Don't hold too many investments
A common mistake made by the Investors Chronicle readers who take part in our portfolio clinic is holding too many investments, in some cases far too many. This is not just a problem for Sipp portfolios – it applies to any investment account.
If you hold too many investments each one only accounts for a small portion of the overall portfolio, so even if one does well its contribution to your overall return will be negligible. You may just end up getting the same type of return as you'd get with a global equities tracker or multi-asset fund – but you will be paying a lot more for it, as you will be paying a fee for each fund and maybe trading charges when you add an investment. High costs eat into your overall return.
A tracker or multi-asset fund could be a good solution if you are starting a Sipp and are not very familiar with investing, have a small fund so do not have enough in it to diversify it across various funds, or don’t have time to monitor and research investments. See the IC Top 100 Funds, the IC Top 50 ETFs and our weekly fund tips for suggestions.
It is also really difficult to monitor the progress of a large number of investments, so you might not notice when something starts to go wrong with one of them, or if one is performing poorly.
If you invest in funds, aim to hold about 10 to 15 at most. Small portfolios should have fewer. A fund is not one investment, it is a basket of holdings and is likely to have at least 30 or more holdings – in some cases hundreds.
If you invest directly in UK equities then don’t hold UK funds that invest in similar parts of the market as well, as you may duplicate exposure. Hold funds that give exposure to overseas equities, other assets and maybe types of UK equities you don't have, alongside your collection of UK equities, if these are appropriate for your time horizon and risk appetite.
Check your workplace scheme first
If you have the option of joining a workplace scheme into which your employer also contributes, in many cases this will be a better option than a Sipp. An employer contribution is a very valuable benefit – in effect free money. If you have money left over after you have made a contribution to your workplace scheme of the size that gets the maximum possible contribution out of your employer, you could consider a Sipp. Also think very carefully before transferring out of an employer scheme that matches your contributions or out of a defined-benefit scheme into a Sipp. There are some circumstances where this may be a better option, but get financial advice first.
Don’t breach your lifetime allowance
The pensions lifetime allowance is a limit on the amount you can draw from pensions without triggering an extra tax charge. For most people this is currently £1,030,000. The rate of tax you pay on pension savings above your lifetime allowance depends on how you take the money in excess of it, as follows:
- 55 per cent if you take it as a lump sum
- 25 per cent on top of any tax payable on the income if you take it any other way, for example pension payments or cash withdrawals.
Even if your Sipp is not in excess of the lifetime allowance, you could still risk breaching it as the amount applies to the value of all your pensions collectively, with the exception of the state pension. So if you have, for example, workplace pensions as well as a Sipp make sure you know the value of these as well as the Sipp to ensure that collectively they do not breach the limit.
You can find more information on how to do this at www.moneyadviceservice.org.uk/en/articles/the-lifetime-allowance-for-pension-savings
If you are approaching the limit, consider stopping contributions into your Sipp, and if necessary other pensions. If you have an employer scheme and your employer is also contributing to it, it might be better to stop contributions to other pensions such as Sipps first, as employer contributions are a valuable benefit. But before making any decisions get professional advice – this is a very complicated area and everyone’s situation is different.
If you have breached or think you are going to breach the lifetime allowance there are schemes to help limit lifetime allowance tax charges, known as Fixed Protection 2016 and Individual Protection 2016. You can find more details on this at www.gov.uk/guidance/pension-schemes-protect-your-lifetime-allowance. But again, if you are in this situation go and see an independent financial adviser. You can find ones that specialise in this area at www.unbiased.co.uk. Also see our article from April 2018 on how to Avoid falling foul of the pensions lifetime allowance.
Don’t breach your annual allowance
The annual allowance is a limit to the total amount of contributions that can be paid into pensions on which you get tax relief. This applies to all your pensions except the state pension and includes contributions made by your employer and anyone else who pays on your behalf, and government tax relief.
If you exceed the annual allowance you will not receive pension tax relief on any contributions over the cap and have an additional tax bill called the annual allowance charge. This charge is added to the rest of your taxable income for the year in question to work out your overall tax liability. The annual allowance is capped at £40,000 or your earnings for the year, whichever is lower.
However, if you earn over £150,000, your annual allowance is less. For every £2 of income above £150,000 a year £1 of annual allowance is lost, up to a level of £210,000 a year. The maximum reduction is £30,000, meaning that anyone earning over £210,000 has an annual allowance of £10,000.
However, you may be able to carry forward unused allowances from the previous three tax years to help increase your tax relief, but you must earn at least the amount you wish to contribute in the tax year that you do it to get tax relief on it, unless your employer is making the contribution. You must also have made the maximum allowable contribution for the current tax year before you can use previous years’ allowances.
If you have started to draw down from a Sipp or defined-contribution pension, other than your 25 per cent tax-free entitlement, your annual allowance may fall to £4,000.
“The money purchase annual allowance is a reduced annual allowance, which is the amount that can be invested tax efficiently into money purchase (defined contribution) pension schemes [and Sipps] and is applicable to those who have already flexibly accessed pension benefits,” says Patrick Connolly, chartered financial planner at Chase de Vere. “But some ways of accessing your pension benefits, such as taking your 25 per cent tax-free cash allowance, cashing in small pensions pots [worth less than £10,000] or buying a lifetime annuity won’t trigger the money purchase lifetime allowance. Taking income from drawdown [above this sum] or taking an uncrystallised funds pension lump sum will.”
An uncrystallised funds pension lump sum is taking money directly from your Sipp without having to go into drawdown. Each time you take money out, 25 per cent of it will usually be tax-free and the rest taxed as income.
“Those who are investing in pensions or accessing pension benefits should ensure they are making the right choices by taking independent financial advice. If you make the wrong decisions you risk not having enough income or a sustainable income, paying too much tax and taking too much risk. These could detrimentally affect your and your family’s standard of living in the future,” says Mr Connolly.
Don’t withdraw too much from your pension in the same tax year
If you withdraw too much from your pension in the same tax year over and above your tax-free lump sum there could be tax implications.
“The rest will be subject to income tax at your marginal rate,” says Mr Connolly. “Withdrawals above the 25 per cent tax-free entitlement are added to your income for that particular tax year. If larger withdrawals are made in the same tax year there is an increased likelihood that more of the withdrawn amounts will be subject to higher-rate income tax at 40 per cent or even additional rate tax at 45 per cent. For example, a pension fund of £200,000 could be reduced to just £132,500 if it is all withdrawn at once.”
Find out more about Sipps with our special guide: