A Self-Invested Personal Pension (SIPP) is one of the best options available for a lot of people in terms of achieving long term financial security.
With the state pension offering a very modest income, question marks over the future of the triple lock and the age at which it is provided moving up, it is not wise to pin your hopes of a comfortable retirement on it.
Some people are in the fortunate position of having substantial work-based pensions coming their way, either through corporate or public sector schemes.
For everyone else a SIPP is a must-have, if it is at all viable. Those with good pensions already in place may still appreciate the added flexibility of having a SIPP – while for self-employed people who have no access to a workplace pension, a SIPP can be a crucial addition to retirement savings planning.
What is a SIPP and how does it work?
A SIPP is a tax-free pension plan that you manage yourself. An investment platform or app will hold the money for you and offer access to a wide range of investment options to select from.
The options include UK stocks, international stocks, bonds, open-ended funds, exchange-traded funds (ETFs) and investment trusts, all similar to what you can invest in within a stocks and shares ISA.
You have full freedom over how your money is invested and your returns will depend on how good your decisions are – in other words how the various assets perform over time. The size and timing of your contributions to a SIPP is also up to you.
With this being the case, it is crucial you do plenty of research or seek financial advice before choosing the investments for a SIPP.
For those not comfortable choosing all their own investments, you can still have a SIPP, but you will need to find a provider that offers “ready-made” or managed SIPPs. These only require you to decide between a small number of broad options, such as your risk tolerance, and the provider takes care of the rest.
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Terms and conditions apply.
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Extra tax advantages of SIPPs
The key advantages of a SIPP over a standard investment account are that your payments into it, or contributions, benefit from income tax relief at your marginal rate (basic 20 per cent, higher 40 per cent, or additional 45 per cent), and also that any capital gains or yield generated by the investments is free from tax.
You can add up to 100 per cent of your income each year, up to a £60,000 cap.
One other benefit worth mentioning is a SIPP gives you the option to consolidate multiple pension pots related to different jobs you have had into one place.
At age 55 onwards (57 from 2028) you can get access to the money, and at that point tax comes into the picture.
There are multiple options available.
Up to 25 per cent of the money can be withdrawn as cash tax-free, but it is capped at £268,275. Cash taken out above that sum is taxed. You can also choose to leave some or all of the money invested in the SIPP, to continue building your position up over time.
The other main option is to use the money to buy an annuity. This means a provider will take your cash and reinvest it themselves. In return, they will guarantee to give you a set income for the rest of your life.
How to open a SIPP
SIPPs are widely available via UK investment platforms. Both the long-standing platforms and some of the newer investment apps offer SIPP accounts alongside individual savings accounts (ISAs) and general investment accounts.
You can only have one SIPP account with any individual provider, but you can have as many SIPPs as you like via different platforms or apps – though you must keep total annual contributions across them all within the £60,000 limit.
Having multiple SIPPs will increase the management demands on you though, so you should consider the implications fully before opening more than one.
Another downside of having more than one is that you will pay fees on each of them. If the fees are all very similar and purely a percentage of your funds, then it will all balance out to the same amount, but if you are paying a flat fee you will be adding to your costs by having more than one SIPP.
Why is a SIPP important for my retirement?
Having a SIPP is crucial to your prospects for a comfortable retirement, unless you have a sufficient corporate pension plan, a public sector pension, or significant sums of money already available to you.
Even if you have plenty of cash, using your SIPP allowance will save you a lot in tax, and for those with decent pensions via their jobs it could still be worthwhile having a SIPP to boost your position.
The state pension provides a safety net but is unlikely to facilitate a comfortable lifestyle on its own, particularly with question marks over its continued affordability for the government as the population gets older on average.
The age at which the state pension is available of 67 is higher than many people would like to retire, and it is expected to move up further over time.
Inflation will raise the cost of living over time, often by more than cash saving rates or pay rises can counterbalance, so investing your money in sound assets is always a wise decision. If it can be done tax-free that is a big bonus.
To ensure financial security in retirement you should start building up your pension as early as you can. Compounding means the returns you make lead to bigger returns as time goes on, like a snowball rolling down a snow-covered slope, so beginning at a young age is very powerful.
When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.