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SIPPs - The DIY Pension

December 8, 2004

SIPP stands for self-invested personal pension and, as the name suggests, it's a type of DIY personal pension where you pick the investments yourself. 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 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.

In the past, SIPPs tended to have fairly high, flat-fee charging structures, meaning that they've usually only been suitable for people with relatively large pension funds. However, the arrival of online SIPPs, with far lower charges, has made them more suitable for a far wider range of people.

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, OEICS, gilts and even commercial property. You can't invest in residential property at the moment, i.e. buy-to-let, but you will be able to from April 2006, when new pension rules take effect. 

In the case of commercial property, 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 that 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, i.e. the online SIPPs, 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 State Second Pension if you're using a SIPP for your pension but the State Second Pension money won't actually go into your SIPP. The Government restricts you on how you can invest State Second Pension money (to keep it safe) so it has to go into something called an Appropriate Personal Pension.

So, are SIPPS a good thing? Well, you can control your own nest egg and you can freely shop around for the annuity you want to buy when the time comes (though you should make sure you can do that with any pension). Interestingly, there is also the added benefit of selling shares outside of an ISA or SIPP to realise capital gains and then buying them back within a SIPP to collect the tax relief on the way in.

As always, low charges and enough flexibility to meet your current and future needs are, as usual, the key Foolish selling points. However, investing in individual shares is more risky than a fund such as a tracker.

> Find out more about pensions here.