Spotlight on SIPPs
More than one million people in the UK now have a Self Invested Personal Pension (SIPP) and demand continues to grow in the wake of the 2015 pension freedoms.
Giving control over investment decisions to the individual investor and the wide range of investment options are the greatest advantages of a SIPP and with fewer private companies providing final salary pensions and state pensions under duress, individuals will increasingly be required to make provision for their own retirement.
Internet technology has been a key enabler in the rise of SIPPs as platforms have made it simple to open, run, monitor and administer a pension entirely online, making them attractive to people who are comfortable making their own investment decisions.
‘control over investment decisions and the wide range of investment options are the greatest advantages of a SIPP’
Once you reach age 55, you may receive up to 25% of the value of your SIPP as a tax-free lump sum and you do not need to retire or stop working before you do so. The remainder will be used to provide a (taxable) income during your retirement.
A SIPP could be the place to consolidate any number of occupational and personal pensions in advance of retirement to create a manageable investment vehicle from which to generate an income in retirement.
Tax Benefits of SIPPs
In common with other personal pensions, SIPP contributions attract basic-rate tax relief which means that for every 80p an investor pays into a personal pension, the government adds 20p, boosting it to a gross contribution of £1.
Higher and additional rate taxpayers can claim back a further 20p or 25p, as applicable, of every £1 gross contribution through their tax return.
‘Internet technology has been a key enabler in the rise of SIPPs’
The pension provider claims basic-rate tax relief from the government and adds it to the pension pot automatically; tax relief is available to all UK residents under 75, including children and other non-taxpayers.
Employer contributions to a SIPP are paid gross and do not count as a taxable benefit so are not liable to income tax or National Insurance.
In addition to the up-front tax relief, the investments within a SIPP can grow free of UK capital gains and further UK income taxes.
Withdrawals of up to 25% of the value of the SIPP can be made tax free when the member reaches age 55 with any additional withdrawals taxed as income.
Money remaining in a SIPP following the death of the member can usually be passed to their heirs without attracting inheritance or death tax. Withdrawals made by the beneficiary should also be tax free if death occurred before age 75, otherwise it is taxed as income.
Eligibility for a SIPP
Most people under 75 will be eligible to set up a SIPP and there is no age limit for transmuting existing schemes into a SIPP.
Those resident in the UK, Jersey, Guernsey or the Isle of Man for tax purposes or Crown employee serving overseas are eligible to open a SIPP and can pay in at least £2,880 per tax year, which is boosted to £3,600 with basic tax relief whether they pay tax or not.
This means that children, retired people and non-working carers or parents are also able to build up a pension pot.
You may also open a SIPP in addition to any other pension plans you may be contributing to, e.g. an employer’s pension scheme, as long as the total annual contributions to your pension funds do not exceed the annual allowance.
Contributing to a SIPP
Contribution rules currently (2015/6) allow investment of up to £40,000 or up to 100% of earned income (if less) per year into a SIPP.
This figure may fall as low as £10,000 p.a. for high earners next year.
Contributions are paid net of tax and the SIPP administrator reclaims standard rate tax at 20% from HMRC to add to the fund. Higher rate tax payers may claim additional tax relief at their marginal rate through their annual tax return.
Contributions into a SIPP may also be paid by a third party, e.g. an employer; however, the total contributions paid into the SIPP may not exceed the annual allowance. If the full allowance was not used in previous tax years, investors may carry forward the shortfall for up to three years and make contributions in a later tax year.
The lifetime allowance of a SIPP is currently set at £1.25 million which will fall to £1 million in 2016/17.
‘The lifetime allowance of a SIPP is currently set at £1.25 million which will fall to £1 million in 2016/17’
This limit applies to total pension savings so if total pension benefits exceed the lifetime allowance when they are taken or an investor reaches age 75, any excess could be subject to a lifetime allowance levy of up to 55%.
You can currently contribute up to a maximum of £2,880 into a child SIPP per tax year to which HMRC will automatically add up to £720 (20%) in tax relief.
Tax relief is based on your child’s status so it does not affect the amount you can put into your own pension; only a child’s legal guardian can open a SIPP on their behalf, but anybody can make contributions up to the annual allowance.
Once your child reaches 18, they will gain control of the SIPP but will not be able to access the proceeds until they are 55; whilst it may not deliver the immediate answer to tuition fees or sky high property prices, the pot will deliver a very healthy foundation for long term financial security.
Given the long investment period for child SIPPs, a small initial investment can grow into a sizeable pension pot by the time your child is ready to retire.
For example, if you were to make a single investment of £3,600 (£2,880 + tax relief) at birth, without ever making any further contributions, assuming 5% annual investment growth, your child would have a pension pot of over £85,000 at age 65.
If you were able to contribute the full £2,880 every year and achieve 5% investment returns until your child turns 18, this would grow to over £112,000; even if no further contributions were made until your child turns 65, 5% annual growth would turn £112,000 into a pension pot of over £1.1 million by age 65.
‘5% annual growth would turn £112,000 into a pension pot of over £1.1 million by age 65’
Inflation will of course reduce the buying power of the pension fund and no account has been taken that rules on tax relief for pensions may also change in the future which might affect the value of the pension fund, but this is a powerful demonstration of the benefits of a long term investment horizon.
According to HMRC up to 60,000 under 18s now have personal pension plans and if they are able to embrace the investment habit whilst wrangling with all the other calls upon their income throughout their early adult years, a Junior SIPP could be the best gift a child could ever wish for in terms of securing their long term financial security.
By way of an example of the benefits of starting early, DIY investment platform Hargreaves Lansdown estimates that paying £300 per month into a Junior SIPP from birth to age 18 could yield a pot worth £579,000 at age 65; paying in the same amount from age 25 to age 65 would yield just £345,000, at a net cost of just over £115,000 – double the cost for nearly half the potential value.
Death of the SIPP Member
When an investor opens a SIPP account they nominate a beneficiary in the event of their death which may be their spouse, child or any other, and when the investor dies, their SIPP passes to them usually free of inheritance and death tax.
If death occurs before age 75, the beneficiary can make any withdraws without incurring any tax liability; if the member was 75 or older, withdrawals are taxed as the beneficiary’s income at their prevailing rate.