A Guide to a Self Invested Personal Pension (SIPP)
In this guide, we will provide answers to the main questions we receive regarding Self Invested Personal Pensions (SIPPs). This will give you a good understanding of the mean features of them and how they work.
What is a SIPP?
A SIPP is a Self Invested Personal Pension, which as it states in the title, is a type of personal pension arrangement.
A SIPP is an extremely tax-efficient retirement savings vehicle, providing you with a platform to save for a better retirement lifestyle. When you contribute to your SIPP, the government will reward your contribution with a top in the form of tax relief. This is one of the most attractive features of a SIPP which is a common reason why many people choose to use them.
SIPPs also offer a much wider range of investment options than standard personal or group personal pension arrangements.
These range from the following:
- UK & Overseas Stocks and Shares
- Collective Investments (i.e. OEICs and Unit Trusts)
- Investment Trusts
- Property and Land
A SIPP is a ‘Defined Contribution’ arrangement that you or your employer may contribute to. However, there are limits on the total amount that can be contributed each tax year if you are to receive tax relief on the contributions.
Under current legislation, you can begin to withdraw your retirement funds when you reach age 55. We will cover the retirement options in more detail, later in this guide.
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Key Benefits of a SIPP
The main key benefits of a SIPP are as follows:
- When contributing to the SIPP you can receive ‘basic rate’ tax relief on the contributions you make. A basic rate tax payer can benefit from 20% tax relief, meaning that your SIPP will be topped up by an additional 20% when contributing to it. As an example, if you contribute £80, the contribution will be topped up by an additional £20, meaning that that the actual amount applied to your SIPP would be £ Higher rate Tax payers can claim 40% tax relief and additional rate taxpayers, 45%.
- The investment funds held within a SIPP can grow free from UK Income and Capital Gains Tax.
- When drawing benefits in retirement, you may take up to 25% as a tax-free lump sum.
- The value of your SIPP does not form part of your estate for Inheritance Tax Purposes.
How do SIPPs compare with other pension schemes?
A SIPP is classified as a ‘Defined Contribution’ pension scheme. This is because your benefits in retirement are defined by the total contributions you or your employer make and investment growth achieved throughout the life of the plan. In comparison to other defined contribution arrangements (i.e. a personal or stakeholder pensions), a SIPP provides greater investment choice for your funds, providing access to a wide range of UK & Overseas Stocks & Shares, Collective Investments, Investment Trusts and Property. Most personal pensions offer a limited range of investment funds which are normally part of the insurance companies own fund range.
SIPPs also provide greater flexibility when taking benefits in retirement as you can take advantage of the flexible drawdown facility. This means you may withdraw as much or as little of your pension fund as you require, providing greater control over your retirement funds. Personal Pensions typically offer the standard retirement options which would be to take a 25% tax-free lump sum and use the remaining pension fund to purchase an Annuity or take no tax-free lump sum and use the full fund to purchase an Annuity.
How much can I contribute to my SIPP?
The amount you can contribute into any UK pension and benefit from basic rate tax relief depends on the level of your salary and the amount of income tax you pay. To qualify for basic rate tax relief you can contribute up to 100% of your salary or up to the annual allowance of £40,000, whichever is lower.
For every contribution you make into your pension, the government will also contribute an additional 20%. This top up is known as ‘Basic-rate tax relief’. This will apply to anyone under the age of 75, even non-taxpayers.
The basic-rate tax relief is automatically added to your pension plan anytime you contribute as your pension scheme provider claims the relief on your behalf and adds it to your pension pot. However, if you are a higher or additional rate tax payer, then the extra relief must be reclaimed through your tax return. Higher rate tax payers can claim a further 20% and additional rate tax payers can claim an additional 25%.
What is the lifetime allowance?
In simple terms, the Lifetime Allowance (LTA) is the total amount of pension savings you can accumulate during your lifetime without being subject to an additional tax charge. The current Lifetime Allowance is £1,073,100. When you reach age 55 and seek to withdraw your retirement funds, if the total value exceeds this limit then you will be liable to a tax charge on the amount above the LTA limit.
How do I withdraw funds from my SIPP?
Once you reach age 55, you may begin drawing benefits from your SIPP.
The options available to you are:
- Annuity: An annuity is purchased using the value of your pension fund. Before purchasing an annuity, you may opt to take 25% of the total fund value as a tax-free lump sum and use the remaining balance to purchase the Annuity. An Annuity will provide you with a secure pension income for life which may be paid to you monthly or annually.
- Drawdown: There are two types of drawdown you may choose which are ‘Capped’ and ‘Flexible’.
Capped Drawdown allows you to draw income from your SIPP which is subject to maximum limits. These limits are calculated by the Government Actuary Department (GAD). Flexible Drawdown allows you to draw as much or as little of your pension funds as you require, giving you much greater control over your retirement funds. Any income you draw will be subject to UK Income Tax at your marginal rate.
- Uncrystallised Funds Pension Lump Sum (UFPLS): This option allows you to draw funds without purchasing an Annuity or going into Drawdown. With this option, you may draw 25% as a tax-free lump sum and leave the remaining 75% to draw taxable pension income.
What is Flexible Access Drawdown?
When you enter into ‘Flexible Access Drawdown’ you can draw as much or as little from your pension as required, providing a greater level of control over your retirement funds. You can benefit from accessing some of your pension funds, whilst leaving funds invested. The term used when accessing part of your pension fund is ‘Crystallisation’.
As an example, you have a pension fund valued at £100,000, you decide to ‘Crystallise’ £10,000, meaning that you could withdraw 25% (£2,500) of the crystallised portion as a tax-free lump sum and use the remaining £7,500 to purchase an Annuity. Alternatively, you could opt to leave £7,500 invested in the SIPP which can continue to benefit from investment growth. The remaining £90,000 would be left ‘Un-crystallised’ and would continue to benefit from potential investment growth.
What happens to my SIPP if I die?
Upon death, your pension funds will be paid to your nominated beneficiaries either as a lump sum or an ongoing pension income. You would need to make sure that you complete a ‘Death Benefit Nomination’ form so that your pension funds will be allocated in line with your wishes. Pension funds do not form part of your estate and therefore will not be subject to Inheritance Tax.
The way in which death benefits are treated varies depending on whether or not your death occurred before or after the age of 75. This is summarised as follows:
Death Benefits where death occurs before the age of 75
In this scenario, the nominated beneficiary may opt to take a lump sum or a regular income. In any event, the benefits will be paid free of UK Income Tax.
Death Benefits where death occurs over the age of 75
The options in this scenario are the same in that the nominated beneficiary may opt to either take a lump sum or receive regular pension income. However, the benefits received will be subject to UK Income Tax.
If a lump sum is taken, this will be taxed at 45%. If a regular income is taken, then the beneficiary will pay UK Income Tax in line with their marginal rate.
This article does not contain personal or financial advice. It is provided for general information only and does not take into account your personal objectives, financial situation or needs. IVCM is not authorized to provide you with any personal or financial advice.
If you require financial any advice then you must make sure that you obtain advice from a suitably qualified financial adviser.