FOOL SCHOOL
Pensions: SIPPs

June 14, 2002

A SIPP is a self-invested personal pension and, as the name suggests, it's a type of DIY personal pension where you pick the investments yourself. Your contributions are topped up by the Government in the form of tax relief.

You can think of it as being a bit like a self-select ISA, in that it's just a wrapper into which you put investments and, like ISAs, there is no Capital Gains Tax to pay on profits. The difference, of course, is that SIPPs are basically subject to the same rules as personal pensions. They have the same limits on contributions, the same 25% restriction on the tax-free lump sum on retirement and the same requirement to buy an annuity by the time you reach 75. If you are frequently paying 40% of your gains over in taxes though, then that extra 40% (which continues to compound within the SIPP) may prove to be attractive -- but balance it against what you can get your hands on at the end!

Traditional SIPPs tend to have fairly high, flat-fee charging structures, which means that, until recently, they've usually only been suitable for people with relatively large pension funds. There is also usually a complex range of charges, which act as an anchor on your overall rate of return. Here are just a few of them: establishment fees, annual administration fees, transfer-in charges, transfer-out charges, investment transaction fees, property fees, income drawdown fees, charges on contributions... I'm sure you're getting the picture!

However, the arrival of the SIPP on the Internet (the e-sipp, of which more later) has brought with it the opportunity for a selection of simpler, low-cost SIPPS which makes them suitable for a far wider range of people.

If you already contribute to your employer's occupational pension scheme then you may not be able to contribute to a SIPP as well. This flowchart on the Inland Revenue web site explains the rules. Your employer can contribute to your SIPP as well. They can also be useful to gather together any frozen pension schemes that you may have left behind from previous jobs -- if it makes sense to do so, of course. The cash from these can then be used to buy the investments of your choice.

The permitted range of investments for SIPPs include stocks and shares on the world's major stock exchanges (and a few of the minor ones too, including those quoted on AIM), investment trusts, unit trusts (such as an index tracker), OEICS, gilts and even commercial property.

The commercial property thing is quite interesting because the SIPP is actually allowed to take a mortgage of up to 75% of the property's value. You can then lease the property to a business which you own (on commercial terms), or to a third party. If you're a business owner, this can be tax-efficient since the rent comes out of the business's pre-tax income and comes into the SIPP as tax-free investment income. As ever, there's a catch, though, which is that the best value SIPPs (such as Sippdeal's e-sipp) aren't geared up to provide this sort of thing, though that's not to say they won't in the future.

You are permitted to contract out of SERPS if you're using a SIPP for your pension but the SERPS money won't actually go into your SIPP. The Government restricts you on how you can invest your SERPS money (to keep it safe) so it has to go into an Appropriate Personal Pension (APP) which holds a contracting out certificate. This enables them to certify the nature of the investments which must be in things such as bank/building society deposits; unit trust based investments; interest bearing deposit accounts; insurance/annuity contracts.

So, are SIPPS a good thing? Well, you can control your own nest egg, there is no upper limit on your pension benefits (company schemes limit you to 2/3 of final Salary), you can decide when you want to retire (between 50 and 75). You can choose to draw down your income and you can freely shop around for the annuity you want to buy when the time comes. Interestingly, there is also the added benefit of selling shares in another portfolio to realise your capital gains and then buying them back within a SIPP to collect the tax relief on the way in.

And, if you were to find yourself declared bankrupt or unemployed, your SIPP is safe from your creditors and from any means test. So you can continue to watch it grow and still have hope that you'll be a zillionaire when you finally retire.

As always, low charges and enough flexibility to meet your current and future needs are the key Foolish selling points. You need to ensure that you invest enough both to beat a low-cost index tracker and overcome any additional charges. The risk is all yours. The risk is all yours. This is so important we thought we'd repeat it. This prospect will either have you salivating over your Jester costume or shaking in your boots, so consider accordingly.

You can get a full list of all SIPP providers from The Sipp Provider Group. We also have a discussion board for discussing what shares to put into SIPPs, which you can find here.

More: Fool's Pension Centre