What is a SIPP?

SIPP means ‘self-invested personal pensions’. To generalise, they are a form of pension that gives an individual the freedom to make his or her own investments into their personal pension fund.

They have been available to the public since their inception in 1989. In April 2006 the UK government made drastic changes to the pension system and allowed all sorts of commodities to be invested into SIPPS, ranging from antiques and works of art while also including cash and shares. One of the more renowned features of a SIPP however was the possibility to purchase property via a SIPP with an added tax break.

However, shortly after creating this new freedom to invest in SIPPS, the UK government took a U-turn over fears that the wealthy might abuse the system. The chancellor later changed the system again to include residential property in SIPPS, but to exclude exotic products like wine and jewellery.

So what are the rules?

As of April 6th 2006 – otherwise known as pension A-day – the government overhauled the pension system making many significant regulatory changes. One of the more exciting changes for high earners was the possibility to pay up to GBP250K into their SIPP each year, rising to GBP255K in 2010.

As the majority of the population earns less than this per annum, the government capped the amount you can contribute and linked it to your gross pensionable income, but like all other pension investments the money will be tax free.

The new pension laws allowed a policy holder to borrow up to 50% of the funds value to invest.

Monies from existing pension funds are able to be transferred into your SIPP free of tax deductions, however it is possible that the relevant companies may charge and administration fee for doing so.

Anyone applying for a SIPP must be under the age of 75.

Investing in exotic products like antiques and classic cars is no longer allowed, however you are able to invest a property into a SIPP if it meets the following criteria:

• The property must have been purchased by a group of 10 people.
• The members of the syndicate must not be related.
• The group investing in the property may not use it for their own use.

The scheme would not be available to investors with buy to let properties or holiday homes.

The rules regarding tax rebates

When an investor’s SIPP fund is used to help purchase a property or other item, HMRC will give the fund a tax credit equivalent to the basic rate of tax, currently around 22%.

If the investor is a higher rate tax payer they can claim a cash rebate at the end of the year when filling out this tax return. They will be able to claim a cash rebate equivalent to the difference between the 22% credit already credited to their fund and the top rate of tax which is currently around 40%.

This 18% rebate will apply to the whole of the initial investment, plus the extra 22% which will be credited to the fund. The end result is that the net tax break will in effect be higher than the official 40%.

Because of the complex way in which tax is calculated and deducted it can be difficult to provide accurate figures, but as a general rule if someone funds a property worth GBP100K they will receive a credit of around GBP28K into the fund, plus a cash rebate of around GBP23K, making a combined total tax benefit of around GBP51K.

Features and benefits of SIPPS

There are numerous advantages to using a SIPP over other forms of pension vehicles, the most notable being the scale of the tax breaks one can receive. Any investment in a SIPP is regarded as tax free, which can mean a discount of up to 40% for higher rate tax payers. For the average wage earner and tax payer savings of around 20% are still favourable.

Using the above example of someone purchasing a property for GBP100K and receiving a tax break of around GBP51K makes for a far more appealing investment.

Are there any disadvantages to SIPPS?

Regardless of the notable benefits to using a SIPP they are not suitable for all and cannot be used as a blanket solution to pension savings. For example, those looking to purchase a property utilising their SIPP fund have many potential issues. Perhaps most importantly of all is that any property your purchase will not in fact be owned by you.

Instead it is owned by your pension fund. This means that in theory you would need the permission of the trustees of the fund to carry out any material of cosmetic changes to the property, creating potential headaches down the line.

More importantly if you are residing within the property you will be subject to pay a market-rate rent, diminishing any savings. You must also consider that your pension fund will also have to cover all the costs involved in purchasing the property.

Anyone who is looking to sell their property into their SIPP pension fund will be subject to stamp duty and legal fees for their own SIPP fund and the person who owns the fund, meaning that a lot of money can be spent on the transaction into their pension fund.

Another point to consider is whether the property is a good investment for the overall performance of the fund. For someone who has a high value fund the risk is negated as their portfolio will more than likely carry other non-property investments that will spread, and hence lower, the risk.

But for someone with less resources it is far more risky to invest a large balance of your pension fund into the property, mainly due to the inconsistency of the housing market leaving the fund a lot more vulnerable to fluctuation.

If you are approaching retirement age and cannot sell the property it could mean having to work longer until the property is sold and you can release the assets.

The majority of financial experts would recommend not having more than 20% of your pension portfolio in property.

How do I get a SIPP?

Although many SIPPS are offered as ‘do-it-yourself’ investments, they are quite complex in legal and tax issues and still require a proper pension fund to be created with trustees.

There are a large number of specialist financial firms and insurers in the market that offer and advise on SIPP products and, like all investments, it’s worth looking around for a fund that works best for you. Many firms will charge to create a SIPP and will also impose an annual administration fee. There is also the possibility of paying separate fees for each of the individual investments within a SIPP.

There are some companies that offer low costs SIPPS without a set up charge or annual fee, however you should carefully look through the charging structure as future gains may be cancelled out by increasing fees later in the term of the plan.

Do I still have to purchase an annuity?

The majority of those with a SIPP may still have to purchase an annuity, however the system is flexible in allowing those who live on a reduced income to avoid paying for one.

Under the current rules you are able to draw down on the funds from your SIPP between the ages of 55 and 75, taking out up to 25% of the fund as a tax free lump sum.

While most are able to use the rest to purchase an annuity, it is also possible to use an alternative called Alternative Secured Income, which allows a SIPP holder to continue drawing down for their fund. However there is a disadvantage using this method. The maximum payments after 75 will generally be equivalent to around 70% of the value of an annuity, meaning it is only suitable for those who can afford to live on a reduced income in their retirement.

One of the advantages of taking an Alternative Secured Income is that when the SIPP holder passes away their spouse or beneficiary will receive the pension. When the remaining spouse passes away the fund will be redistributed to other family members but will be subject to inheritance tax.

Can I avoid inheritance tax?

Put simply yes, it is possible to avoid paying inheritance tax upon death. If the policy holder dies and there is still a value left in the fund, members of their family could be able to inherit the remaining amount without paying inheritance tax.

While this could be a significant amount, knowing exactly what savings can be made is not clear due to the Inland Revenue’s rules on such transactions, which can be a bit of a grey area.

The Inland Revenue can view the transaction and if they determine that the SIPP was specifically designed to avoid paying inheritance tax they could decide to pose a charge.

It is strongly recommended that you seek professional advice when discussing inheritance taxation on a SIPP due to the varying nature of each individuals needs.

The final word on SIPPS

Although for many SIPPS can be a fantastic vehicle to provide for your pension, you should be wary that they are not suitable for all and their performance and potential can vary drastically depending on the circumstances of the individual.

As always, it is recommended that you search the market extensively and seek a professional opinion before embarking on any financial projects.