Pension planning is an unavoidable reality for anyone under the age of 65. But according to numerous reports, the UK is facing a pension crisis, as the official state retirement age rises and too few people are saving into private pension funds.
Research from both private companies and government bodies has concluded that the average pensioner needs an income of at least £18,000 per year in order to maintain a good quality of life. However, the basic state pension is currently just £122.30 per week – or £6359.60 per year. That’s a gap of £11,640.40 per year that needs to be filled by a personal pension.
Clearly, the vast majority of Britons need to start taking control of their pension savings. One way to do this is by using self-invested personal pension, or ‘SIPP’, which gives you greater freedom when investing in your pension.
What is a SIPP?
A SIPP is simply a pension fund that you manage yourself. It functions in a similar way to a stocks and shares ISA, in that everything saved within the SIPP wrapper is completely tax free until you start to make withdrawals. On top of this, the government will top up your SIPP savings by a massive 20%, and you can take up to 25% out of your total fund at the age of 55 without paying a single penny in tax. SIPPs are subject to the same tax benefits as other types of pension.
SIPPs were introduced in 1989, and pitched as a way of handing back control to British taxpayers by allowing individuals to create their own pension portfolio. Today, scores of investment houses and advisory firms offer SIPP services to help taxpayers make sense of their options, and maximise their tax-free returns.
Every UK taxpayer under the age of 75 is entitled to open a SIPP. Most SIPP holders can save up to £40,000 a year without incurring a tax charge across a wide range of asset classes, such as stocks and shares, bonds, gilts, and funds. Each allocation can be changed at any time, so that your SIPP always reflects your own risk horizon and interests.
By shielding your pension fund within this tax wrapper, you can avoid paying capital gains tax or income tax on any interest earned on your capital investment. Furthermore, the government will top up any SIPP contributions by the basic rate of tax (20%), so you are essentially getting a tax refund on any SIPP savings. For instance, if you were able to invest the full £40,000 a year into a SIPP, you would receive an £8000 bonus on top of the interest or returns which you have earned through your portfolio. And if you automatically reinvest those returns and your government bonus, you can substantially grow your capital year after year.
On your 55th birthday, you can withdraw up to 25% of your SIPP in a lump sum, to spend, gift or reinvest. Anything that you withdraw after this will be subject to your usual rate of income tax. However, most people go down by at least one tax band after retirement, so by delaying your withdrawals you can still make a significant saving on your tax bill.
Always bear in mind that individual tax circumstances can differ and tax laws can change.
Benefits of a SIPP pension
The main benefit of a SIPP is that they allow you to save for retirement without worrying about unnecessary taxation. But SIPPs also offer a degree of flexibility that isn’t available from a standard pension fund.
Experienced fund managers will argue that you pay higher fees for their expertise and the time that they spend researching the best investment options. However, in the current economic climate, many people prefer to save on manager fees by making these decisions themselves, or investing in low-fee investment tools such as exchange traded funds (ETFs), which offer instant diversification.
Furthermore, it is worth remembering that a fund manager will be investing on behalf of thousands – maybe even hundreds of thousands – of other people, all with different expectations, interests, risk horizons and incomes.
A SIPP, meanwhile, is just for you. You can decide what you want to invest in, and what you want to avoid based on your own risk appetite and your investment horizon. For instance, a 20-something worker may choose to invest in a combination of 30-year bonds (low risk; long-term investment horizon) and stocks (higher risk; short-term investment horizon), while a 50 year-old business owner may prefer to invest in five-year gilts (low risk; medium-term investment horizon) and FTSE 100 equities.
Before you start saving into a SIPP, do a bit of research and find out which provider can offer you the best range of investment options, and the best set of rates. After that, all you have to do is set up regular payments and check in on your portfolio from time to time to make sure that you are still happy with your chosen allocations.