Self-Invested Personal Pensions SIPPs

What are they and what is the benefit to you?

Self-Invested Personal Pensions (SIPPs) represent an unrivaled amount of freedom and flexibility for your retirement and investments. Discover what they are and how you can make a plan like this work for you.

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Self-Invested Personal Pensions (SIPPs) Introduction

The majority of people that have a history of UK employment have built up pension benefits in various schemes which may now not be suitable to their specific requirements.

In many cases the pension scheme or schemes you become a member of whilst working in the UK, were not your choice, but yet these pensions could end up or already be one of your biggest investments and a considerable part of your retirement plan.

Professionals working for the same company all with very different needs and goals all having the same scheme means that some employees have a suitable pension and others perhaps the opposite.

This guide aims to explain how Self – Invested Personal Pensions (SIPPs) may be a more suitable home for your pension benefits and how it might be used to fund your retirement.

Main Types of Pensions

Occupational – This is a pension scheme set up by an employer for its employees which both contribute towards.

These can be either money purchase defined contribution (money purchase) or defined benefit (final salary).

Stakeholder – A low cost defined contribution pension scheme introduced in 2001 aimed at low earners to help them get the benefits of a pension in a cost-effective way.

Personal – These schemes are individual and set up by you through a financial advisor or by going directly to a personal pension provider. Although all personal pension will allow employer contributions not all employers will contribute.

What are Self-Invested Personal Pensions (SIPPs)?

Personal pensions can give you a much wider range of available investments compared with employers occupational defined contribution scheme.

A SIPP and a QROP are both types of personal pensions. A SIPP is a UK pension so governed by UK rules and regulations and a QROP (qualifying recognized overseas pension) is governed by the regulation in whichever country it belongs to, these are usually Malta, Gibraltar and Guernsey.

How Self – Invested Personal Pensions (SIPPs) Works

Self-Invested Personal Pensions really allow you to take control of your retirement money and investments. It offers the most flexibility out of all UK pensions and although anyone can start a SIPP, in the offshore world they typically come with the added benefit of a financial advisor.

As with all pensions they are highly tax efficient and as with other personal pensions, you can add money as and when you like and withdraw as and when you like after 55.

The added benefits to a SIPP over a personal pension is the freedom to invest. Standard personal pensions can sometimes be ‘cheap and cheerful’ which often means access to only a few funds which are selected by yourself and usually the providers own funds.

A SIPP allows you to have a highly personalized investment strategy therefore perfectly suitable to your needs and risk.

Lifetime Allowance

This is the total amount you can have in all your UK pensions added together without some fairly hefty tax penalties. The amount is currently GBP 1,073,100 and has changed drastically in the past decade, correct, not in your favor.

All pensions are measured against this allowance whenever you take money from your pension and / or when you reach 75 or on certain transfers.

You can apply for protection although this whole subject is fairly complex and I suggest speaking to a professional.

Investment Options

Self-Invested Personal Pensions (SIPPs) have an extremely wide range of assets available all pf which grow without any income tax or CGT within the SIPP. They can be self-selected or recommended by a financial advisor. Popular options include:

Collectives
Investment Trusts
ETF’s
Direct Equity
Direct Bond
Structured Products
Cash and Deposit Accounts

The other alternative is to outsource the management by giving custody to a professional investment manager whom provide external discretionary portfolio management services in the form of a ‘Managed Portfolio Service’ or even ‘Bespoke Portfolio Service.’

This makes a SIPP to be a highly personalized retirement scheme that you are fully in control of.

Options at Retirement

As with all UK pensions you can take 25% of the value of the pension as a PCLS (pension commencement lump sum) which are more commonly referred to as ‘tax free cash’ and everything else is taxed as income.

Thanks to the rule changes in April of 2015 you have 100% unrestricted access to the money within a SIPP. You can literally withdraw all or none of it and anything in-between.

There are 3 main options to take money out of Self-Invested Personal Pensions (SIPPs); of which you can also chose a mixture of to suit your needs:

Annuities

You can choose to buy an annuity with some or all of your SIPP fund. This will provide you with some certainty regarding fixed costs and guarantees the pension will not run out in your lifetime.

Annuities are available from most insurance companies and the income you receive will depend on a number of factors including your age, health and whether the annuity income will include a spousal benefit.

An annuity takes away any investment risk as the risk is borne by the insurer. Although other risks include the amount you get not being as much as you paid for the annuity. Also, if inflation increases your retirement income technically reduces.

Once you give any money to an insurance company you effectively lose right to your capital as you give it up in return for an income stream, therefore nothing for any beneficiaries.

Drawdown

This can mean either flexibly withdrawing or taking regular income. The income can be either taken from profit from funds I.e. dividends, coupons or interest or by selling part of an asset.

Typically, the money not withdrawn remains invested therefore subject to market movements so a higher risk strategy than buying an annuity.

Flexible drawdown can be beneficial if the amount of some of your other income varies as you could choose to take an amount from your pension that doesn’t push you into a higher tax bracket.

It can also be useful for those wanting more capital in their younger years or not wanting any at all if markets haven’t been great.

Take Direct Lump Sums

Also known as Uncrystalized Funds Pension Lump Sum (UFPLS) which lets you take money directly from your SIPP without having to choose drawdown. Each UFPLS is 25% tax free and 75% taxable. The best way to describe it is a slice of the whole pot.

Mix and Match

The flexibility of drawdown options allows you to customize your income and have tax planning opportunities. You could buy an annuity with part of the pot which would cover fixed expenditure then have all discretionary spending in the form of flexible drawdown.

What Hapeens When
You Die?

When you die your SIPP does not form part of your estate can be passed to beneficiaries in most cases without inheritance tax. You can nominate one or more beneficiaries which are usually a spouse or child but it can be anyone and any number of people.

Assuming you didn’t purchase an annuity and there’s wealth left over your beneficiaries essentially have the same options as you. This, along with no IHT means that SIPP’s can be a very powerful succession planning tool. They can effectively be left down generations with beneficiaries accessing the wealth as they need / want it or maybe even not at all.

If you we’re to die pre 75 the benefits passed to a beneficiary are tax free regardless of the amount the beneficiary decides to withdraw. Death post 75 means beneficiaries are taxed as income.

Self-Invested Personal Pensions (SIPPs) After you die

SIPP contributions receive income tax relief at your highest marginal rate if contributing as a UK tax resident subject to some restrictions

The underlying investments growth free of income and capital gains tax

There’s no tax charge when transferring existing pensions into Self-Invested Personal Pensions (SIPPs)

There could be favorable tax treaties with other countries meaning lower income tax due than the various QROPS jurisdictions

On death, beneficiaries either pay no tax or their own marginal rate depending on the age which you pass. There is no fixed tax charge on the death of the member

Up to 25% of the pension is paid tax free from the UK and received tax free in most countries

A Summary of the Tax Advantages of Self-Invested Personal Pensions (SIPPs)?

As a general rule the UK will pass taxing rights to the members country or residence on drawdown but it depends on the DTA (double taxation treaty) between the two countries, if one exists. The UK currently has over 130 different tax treaties.

There are a few jurisdictions that the pension income from a SIPP is taxed at zero and one of these includes the UAE, Saudi, Qatar and Malaysia.

In some scenarios it’s possible to remove your entire pension benefits from the system and relief the entire amount from UK income tax. This is a complex subject and process and expert advice is advised.

A Summary of Non-Tax Advantages of Self-Invested Personal Pensions (SIPPs)

Full access from 55 years old (57 from 2018)

Control of where the money is distributed on death

Multiple currency options to suit your needs

The ability to personalize your investment strategy

Allows consolidation of more than one pension

The ability to transfer to other pensions such as QROP’s or Superannuation’s easily

Outside the UK a SIPP usually comes with the added benefit of a financial advisor

Transferring Pensions Into Self-Invested Personal Pensions (SIPPs)

It’s generally not a good idea to transfer any pension benefits where you are still receiving the tax advantages on the contributions from UK earnings or the transfer would mean losing employer contributions.

If you’re a deferred of any pensions (not contributing) a SIPP maybe the solution. A SIPP will take transfers from all types of UK including other Self-Invested Personal Pensions (SIPPs) and overseas pensions (QROPS).

Pension schemes can be broken down into 2 main categories which are defined benefit, also known as final salary and only are only occupational, and defined contribution schemes which can be occupational or personal.

I have highlighted below some of the reasons people transfer the different types of schemes.:

Transfers from Defined Benefit Schemes:

You might give up your guaranteed benefits from a defined benefits schemes because you prefer a more flexible income

You may prefer the higher death benefits for your beneficiaries

You may have just had a transfer value you couldn’t refuse.

You might want to access more of your pension at an earlier age for an increased lifestyle or potential short life expectancy

You may require different currency needs to GBP

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Transfers from other Defined Contribution Schemes:

Your existing scheme may have a limited fund range or funds that are not performing very well

Self-Invested Personal Pensions (SIPPs) may have a more favorable tax treaty with the country you have

You may want to consolidate many other pensions for ease of administration

You may prefer a more personalized investment strategy

You may require access to more currencies than GBP

You may transfer your benefits from personal pension

What to Watch out for!

Excessive Fees

There are several fees associated with setting up a personal pension. Every firm will have different fees and their recommended trustee, platforms and investment managers will also with different fees.

I have listed below the what fees can expect to pay when transferring a pension. If they are any higher than the below, ask extra questions. It’s very common in the offshore market for their firms to look for extra ways to get paid.

Excluding you and your current defined benefit trustee. The parties involved in transferring a defined benefit scheme into your new personal pension are:

Financial Advisory firm and advisor
UK pension transfer specialist company
SIPP / QROP Trustee
Investment Platform
Investment Manager / Portfolio manager

Follow the guidelines below so you are well informed for any dealings with advisory firms:

Initial Advice Fee

This is the fee that the advisory firm charges for their advice process and for facilitating the transfer. It ranges from 1% to 7% (I have even seen 8%) and is mostly paid from your pension directly to the advisory firm.

There are 2 options in the way to pay your financial advisory firm and that’s via commission or an upfront fee. Generally, its commission in the less regulated markets and an upfront fee in the more regulated markets and generally comes from your pension although that’s not mandatory.

The commission way will mean 100% of your pension is invested on day one and you’ll have exit penalties should you exit the investment platform. This can be a powerful way to set up your pension if the fee is reasonable but if the fee is high it will drag on performance. As a general rule, if your platform fee is 1% per annum for 10 years i.e. 10%, the advisory firm is being paid 7% upfront.
The fee way usually involves an ordinary investment platform where the fee is taken at the start. It usually ranges from anywhere between 2% & 5% depending on the size of the pension and the recommending company. This is the only way advisors can charge in the UK as its transparent and comes with no exit penalties.

Either way ask for full transparency and there’s nothing wrong with asking how much the adviser gets paid. My advice is you shouldn’t be paying any more than 5% whether its upfront or in the form of commission.

The truth is you can literally design your own charging structure within a personal pension. My advice is to compare both ways.

Be wary of anyone that says ‘don’t worry about fee’s, we get paid by the product provider as this is far from transparent. Who do you think pays the product provider… that’s right, you!

Investment Platform Fees

The platforms that have the option to pay commission to the adviser as mentioned above typically have admin fees which continue for the life of the platform. These are typically, around 400 GBP per annum but as a percentage of a £100,000 transfer its 0.4% in addition to the amount they collect from you for indemnifying the commission to the advisory firm, assuming commission was paid.

The ordinary platforms have an annual management charge of between 0.3% and 0.4% which runs for the life of the platform and is based on the value of the pension.

Ongoing Advice Fee

This usually ranges from 0.5% to 1% depending on the size of the pension and will fluctuate with the new pension fund. Sometimes the underlying investment strategy pay the ongoing fee to the advisory firm.

Don’t be fooled, if a fund pays 0.5% back to the advisory firm that fund is exactly 0.5% more expensive than the ‘clean’ version of that exact same fund.

Again, you want absolute transparency here and ideally you agree a service fee which is then paid via the platform and not from the underlying investment strategy.

Trustee Fees

Both set up and ongoing fees are paid to your new trustee until you drawdown. SIPP set up fees are usually around £300 and annual admin fees of £500, this means upfront you have £800. QROPS are usually around double. Please note some trustees have ‘light schemes’ for smaller amounts.

Portfolio Manager Fees

Some advisory firms will choose to use a portfolio manager to run their client portfolios. This can be highly beneficial and lower risk for the company however (more below) external ones are usually by far the best and annual management charges range from 0.3% – 0.5%.

Underlying investment / fund manager fees: This all depends on the strategy and can range from almost negligible to around 0.7%. A portfolio manager selecting stocks pays very little for that but a portfolio manager selecting a range of external funds

My advice is to plot ALL fees on a excel file converted into a percentage of your pension value. Be mindful that if this gets to above 3% you will struggle to achieve any real growth after inflation unless you’re an aggressive investor.

Past Performance of Proposed Funds

Still one of the most common statements in financial services and its true. I urge you to delve a little deeper. Yes’ if a portfolio management company consistently out performs their peer group and benchmarks there’s a good chance they will continue to do so but is there anything else at play here.

The best example I can give is where an investment fund is denominated in GBP but mainly holds US companies denominated in US Dollars. At the moment these look fantastic however most of the out performance is due the weakening of GBP against the USD.

Internal Funds

Very common with firms trying to increase their ongoing revenue is for them to bring the management of client money is to do it in house. This means you still pay the same but the firm gets to keep more and you have far less expertise however I have seen internal funds running at over 3% with awful performance to match.

Summary

There are some great financial advisory firms outside the UK but also, the exact opposite. A few last words of wisdom would be to make sure:

Any advisory firm is regulated
The advisor they select for you is qualified to UK level 4 minimum and has testimonials
You are not rushed into a decision
You are thorough and consider all possible future scenarios
You are offered to pay via a fee and not just commission
You get clarity of ALL fees and do your excel file

As always Expat Wealth Adviser is here to help, feel free to reach out for anything from an initial conversation to a full analysis of a proposal for a transfer of your pension to a personal pension.

Self-Invested Personal Pensions (SIPPs)