If you’re wondering what a SIPP is and how it works, here’s everything you need to know to start taking your pension into your own hands.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
What is a SIPP?
A Self-Invested Personal Pension, or SIPP, allows investors to take control of their pension. SIPPs could be a perfect fit for investors who are confident in managing and building retirement wealth rather than relying on professionals.
This special type of investing account allows individual investors to own a wide range of stocks and funds. Apart from providing more choices, SIPPs usually have lower fees compared to professionally managed pension funds.
Having said that, it’s often common that a SIPP is used as a secondary pension. Employees who want to put extra money aside for retirement and have already maxed out their employer pension scheme may turn to a SIPP. It also serves as an excellent pension-building vehicle for those who are self-employed.
Tax benefits of a SIPP
Unlike a regular investment account, SIPPs provide powerful tax advantages designed to replicate the tax benefits of an employer pension scheme.
Just like a Stocks and Shares ISA, capital gains and dividends can be earned entirely tax-free. However, unlike an ISA, SIPPs offer additional tax benefits, most notably in the form of tax relief.
RELATED: What Is Capital Gains Tax in the UK?
Typically, when money is contributed to an employer pension scheme, it is taken out of a monthly salary before taxes have been applied. However, whenever money is contributed to a SIPP, this occurs after income taxes have already been paid.
Therefore, contributions to a SIPP are given tax relief to refund this previously paid tax, resulting in more capital to invest. The amount of tax relief provided is dependent on an individual’s income tax bracket. Someone paying the basic rate would be entitled to 20% tax relief. However, someone fortunate enough to be in the higher or additional tax brackets could claim up to 40% and 45% tax relief, respectively.
To demonstrate, let’s say someone has just deposited £1,000 into a SIPP. How much money would they have to invest after-tax relief under the current tax rules of 2024/2025?
| Basic rate (20%) | Higher rate (40%) | Additional rate (45%) |
| £1,250 | £1,667 | £1,818 |
It’s important to note that tax relief and income tax rates and brackets may change over time.
What investments can be held in a SIPP?
Just like an ISA or another brokerage account, a SIPP can hold a variety of different investments, including:
- Stocks and equities
- Unit trusts
- Exchange-traded funds (ETFs)
- Investment companies
- Real estate investment trusts (REITs)
- Corporate bonds
- Government bonds
- Mutual Funds
- Index Funds
What is the SIPP allowance?
Because of the tax advantages offered by a SIPP, there are limits to how much an investor can put aside each year. This is the same principle as a Stocks and Shares ISA, in which only £20,000 can be added each tax year. However, for a SIPP, the allowance is considerably greater.
SIPPs currently have an annual allowance of £60,000 per tax year. And unlike an ISA, this allowance rolls over. If an investor doesn’t use their entire annual allowance, unused allowances can still be claimed from the previous three tax years.
The annual allowance for SIPPs has only recently been increased to £60,000 from £40,000 in the 2023/2024 tax year. As such, because of the rollover benefit, an investor in the current 2024/2025 tax year could contribute up to £200,000 (£40,000 + £40,000 + £60,000 + £60,000) today depending on how much allowance, if any, had been used over the last three tax years.
What are the disadvantages of a SIPP?
While SIPPs offer a lot of powerful advantages, these also come with some notable drawbacks that investors must consider.
While investments that are held within a SIPP are immune to taxes, HMRC eventually re-enters the picture when it comes to withdrawing money. With an ISA, any gains earned are still tax-free once they are withdrawn. With a SIPP, withdrawing funds counts as income and triggers an income tax event.
The first 25% of a SIPP can be withdrawn tax-free, just as with any other type of pension. However, further withdrawals after this point are where income taxes re-enter the picture.
Currently, British citizens can receive up to £12,570 in tax-free income. Therefore, for someone whose sole source of retirement income comes from their SIPP, withdrawing a maximum of £12,570 per year will result in no tax to pay. However, withdrawing more than this will require taxes to be paid.
In other words, investors can use a SIPP to grow their wealth tax-free but then must pay taxes later – it’s effectively a tax-deferral scheme.
There is also the age restriction to consider. Anyone under the age of 75 can open and contribute to a SIPP. However, since this investment account is designed to be a pension-saving vehicle, withdrawals cannot be made until after reaching the age of 55. This minimum threshold is being increased to 57 as of 2028, and it could be increased further in the future.
SIPP fees
The fees charged for a SIPP will vary depending on the provider. It’s quite common that providers will charge a % of account value annual fee (usually around 1%), but there are some brokers that offer flat rates instead, which can be more cost-effective in the long run, especially for individuals who build a substantial SIPP.
Additionally, there are also trading fees to consider. Whenever buying or selling investments, brokers will charge trading fees on each transaction, which can rack up costs, especially when trading frequently.
How risky are SIPPs?
As with any investment, the price and value of assets and securities can go up and down. As such, SIPPs are not risk-free retirement wealth-building devices. The amount of risk an investor is exposed to ultimately depends on what’s included in their portfolio.
Someone who exclusively buys government bonds is typically going to have significantly less risk exposure compared to someone investing exclusively in growth stocks. However, while the latter is likely far more volatile, it also offers the potential for significantly better returns, resulting in potentially greater long-term wealth.
Investors need to find the balance between risk and reward that is right for them based on personal risk tolerance, investment objectives, and time horizon.
What happens if your SIPP provider goes under? The good news is investor capital is still protected by the Financial Services Compensation Scheme (FSCS) if the provider is regulated by the Financial Conduct Authority (FCA). Therefore, while it may take some time to regain access to purchased shares as they are transferred to another broker, invested capital will not be lost.
How to open a SIPP
As with any other investment account, opening a SIPP can be done in three main steps.
1. Choose a platform
SIPPs are offered by a wide range of providers, and investors should spend time looking at their options. In general, the features investors should look for are access to a broad range of investment options and low account and trading fees.
However, it’s paramount to ensure a provider is registered with the Financial Conduct Authority. Otherwise, there may be very few protections in place should the provider declare bankruptcy or prove to be a scam.
2. Choose which investments to hold
With a platform selected, the next step is to determine which investments are the best fit for your portfolio.
There are services available to help pick investments, such as The Motley Fool Share Advisor. Additionally, investors who prefer having a professional overseeing their retirement wealth can hire an investment advisor or use a ‘robo-advisor’ if they wish to minimise fees.
3. Fund your account
Once a portfolio has been designed and a SIPP account has been opened, the last step is to fund it and then begin investing.
Typically, tax relief on SIPP contributions is automatically added after a month. However, investors who are claiming more than 20% tax relief may have to fill out additional documents and submit a formal relief request to HMRC.