Everything You Need To Know About Self-Invested Personal Pensions (SIPPs)

What is a SIPP? Find out if a self-invested personal pensions (SIPP) is a good idea for you and how they work.

Aside from their name, I believe pensions are glorious things and, if used in the right way, can prove a great way to save tax efficiently. Before embarking on everything you need to know about Self Invested Personal Pensions (SIPPS ), remember this: Everybody will be affected by pensions at one point in their life; either by funding them or at retirement and beyond. There is NO escape from pensions. They are pretty much a certainty.

In March 2014, George Osborne stood up at the lectern to pronounce his Budget 2014 and produced a left field moment when he announced: “Let me be clear: no one will have to buy an annuity”.

From that moment an individual had full control of their pension. No longer was an annuity the default option, withdrawals became unlimited – although subject to tax law – passing on pension capital to future generations tax efficiently became possible, consequently, changing the order by which savings are spent in retirement. However, with this freedom also came some risk, as it now became much easier to run out of money.

What is a SIPP?

A Self Invested Personal Pension is a savings vehicle to which individuals and employers can contribute. Differing from a Personal Pension, which is typically provided by an insurance company and likely to consist of a limited range of funds and methods by which income can be drawn, a SIPP is likely to prove access to an extensive fund range, direct equities, exchange traded funds and commercial property. Money can be added to a SIPP and, provided you’re under the age of 75 and a UK resident, you’ll receive 20% tax relief. Higher-rate taxpayers and additional rate taxpayers receive an additional 20%/25% which must be reclaimed through the completion of a self-assessment.

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How important is SIPP tax relief to long term planning?

Consider the following example where an individual saves £8,000 per annum:

The difference of £43,439 in the Potential Lump Sum highlights the importance of tax relief. For without it, to achieve equivalent results, more needs to be saved or a higher level of investment risk taken.

Once money is held inside a SIPP, it will grow free of income tax and capital gains tax. Usually, 25% of the pension fund is available as a pension commencement lump sum (also known as tax free cash) from age 55, but as of 2028 this rises to 57. For some older schemes protected tax free cash may be applicable. For the remainder, consideration may be given to using an annuity, income drawdown or uncrystallised pension fund lump sum (UFPLS), or a combination of all three, and there’s a common misconception that you’re only able to use one option.

If only SIPPs were as simple as this, however. Beneath the surface lies several complexities where you might need the expertise of a financial planner.

The Annual Allowance – the maximum annual contribution is £40,000 per annum. It’s possible to carry forward unused allowances from the three previous years enabling an exceptional contribution if earnings permit. For those with an adjusted income of over £240,000, the annual allowance is tapered. Any excess contribution is liable to an annual allowance charge of 45%. It’s the individual’s responsibility to declare this.

Things you need to know about SIPPs

The Lifetime Allowance Charge

The lifetime allowance charge for 2021/22 is £1,073,100 and has been frozen at this level until April 2026. Any excess over this limit is liable to the lifetime allowance charge, which if drawn as capital is 55% or if drawn as income is 25%. The decision to freeze the allowance for the next five years has the potential of raising an increased level of tax revenue for HMRC.

For example: Take a 50-year-old who has a pension fund of £750,000 and is saving £30,000 per annum into it. In five years’ time the pension fund is approximately £1,106,143 – assuming growth of 4.5% per annum. Unexpectedly, this individual has a problem and by doing what they’ve thought is the right thing they now find themselves with a lifetime tax charge liability. Perhaps it’s time to seek advice and consider options.

The money purchase annual allowance (MPAA)

A little-known implication of drawing down an income from your SIPP is that once taking an income the maximum contribution you can make to a SIPP is £4,000 gross annually. This can have significant implications on how you save should you remain employed – for example, how do you make best use of an employer’s pensions scheme?

Upon death, it is possible to pass on your SIPP to a surviving spouse and children. SIPPs have now become inter-generational and a great way to pass wealth on free from inheritance tax. Tax implications differ based on age at death. If death occurs before 75, beneficiaries can withdraw what they like from the pension without paying tax. However, if this happens after age 75, withdrawals will be taxed as the beneficiary’s income.

SIPPs are a fabulous savings vehicle with many benefits if maximised properly. However, there are several complexities that can cause substantial tax liabilities and now might be the time to consider your options. It may be possible to mitigate potential issues by having a conversation with a financial planner.

Written by Marcus Rayer Chartered ALIBF , Independent Financial Adviser/Chartered Financial Planner, Integrity365

Customer service is at the heart of everything Integrity365 do, from the early days of pensions and ISAs to investments and lump sum decisions, through to retirement and later life planning, they are here to support you through the key stages of your life with a holistic approach to financial planning.