Pension Advice - Sipps

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Sipps: an introduction

Self-invested Personal Pensions (Sipps) offer greater flexibility and have become very popular since pension regulations were simplified in 2006. However, they can be risky if you make the wrong choice. How do they work? Should you look into getting one? We outline the pros and cons.

Spread the risk

Many wealthy individuals are no longer satisfied with leaving their retirement nest eggs in the hands of underperforming fund managers, and so are increasingly switching to DIY personal pensions.

Self-invested personal pensions (Sipps) offer far greater flexibility than ordinary personal and occupational pensions because you can have many types of investment in them, including British and foreign stocks, unit trusts, investments trusts, managed life funds, unit-linked funds, and even commercial property.

This allows you to spread the risk of products or providers performing badly. If you are unhappy with the performance of your ordinary personal-pension provider, switching to another provider is simply not cost-effective in the early years because charges are often loaded on to the first years' contributions.

You are effectively forced to freeze your pension and start up another one with another provider, incurring more set-up costs.

Aggressive strategy

Sipps give you the freedom to switch out of poorly performing investments. They also offer the potential for much better returns, because policyholders can adopt a more aggressive investment strategy than large pension funds. Yet they enjoy the same tax reliefs as ordinary personal pensions.

Although Sipps have been around since 1989, they are only just taking off, thanks largely to a recent change in pension rules.

On reaching retirement age, pension policyholders can now draw an income from their pension fund rather than buying an annuity straightaway.

Under the open-market option, they can shop around for the best annuity deal and have up to the age of 75 before they have to buy one. This freedom is prompting policyholders with maturing pension funds of at least £250,000, say, to transfer their funds to Sipps.

Income

Sipp-holders can also draw an income from the fund without having to retire. Most occupational pension schemes do not allow this.

Investors are also realising the benefit of selling shares in their portfolio, making gains within the annual £9,200 capital-gains tax (CGT) limit, and then buying the shares back within a Sipp to get the tax relief on the way in.

High charges

There are disadvantages, however. Typical charges are one percent of the fund size to set it up, followed by a 0.6 percent annual management fee, and dealing and investment advice costs on top. There is usually a set-up fee and then annual running charges - these can be as much as £500 a year for a plan that allows savers to invest in property. You are also charged each time you buy or sell an investment or take income from the Sipp.

The other disadvantage for those who have reached retirement age is that the level of income they draw is dependent on the performance of the underlying investments. If they do badly, the income will suffer. And you could also end up with a much-reduced pension fund from which to buy an annuity.

Only the wealthy can really afford to take out a Sipp to start off their retirement fund.

David Hutt of the specialist pensions adviser RE Hutt Group says: "Sipps are most suitable for self-employed people who are enjoying good incomes because administration costs are far greater than with ordinary personal pensions."

Matthew Orr, partner at the stockbroker Killik & Co, which is enjoying an increase in Sipp business, says: "This type of pension is really not cost-effective unless you are contributing at least £10,000 a year to your fund."

There are about 30 Sipp providers, with Scottish Equitable, Sun Life, and Legal & General leading the pack. The market is still so small that the Association of British Insurers has not collated data on its size. But a spokesman says: "With the rate these pensions are growing in popularity, we will have to start looking at them closely very soon."

The Financial Services Authority has warned that some people who would be better off with a simple stakeholder pension have been mis-sold Sipps.

You should only opt for a Sipp if you are comfortable making your own investment decisions. If in doubt, talk to a financial adviser. Picking an expensive Sipp over a safer option could cost you more than £20,000 in lost growth over a decade.