Self-invested personal pensions

Self-invested personal pensions, or Sipps, were expected to become very popular when the new A-Day pensions regime goes live in April next year. This was to have given investors the opportunity to invest in a wide range of alternative assets from residential property and expensive wine to vintage cars. But this week’s pre-Budget report has effectively put an end to all these new investment opportunities. Despite this, Sipps still have many attractions for investors who want more control over their own pension investments.

A big fear for some administrators was that the risks of allowing investors to shelter quirkier investments would outweigh the benefits. Some administrators are happy about this week’s news simply because it makes life simpler for them. For a Sipps administrator, allowing someone to invest in, say, a classic car would have been a risky proposition. Under the proposed rules as they stood before this week’s changes, the Sipp would own the car. So if an investor were to take it for a spin, the Sipp would have had to take on the cost of the insurance cover. If the driver had an accident, the Sipp would be forced to meet the costs of expenses not covered by the insurance.

What is a Sipp?

To use a simple analogy, if a personal pension is a compact-disc player, then a Sipp is an i-Pod. A Sipp has all the normal tax breaks of pensions, so profits are exempt from capital gains tax and investors can claim income tax relief on contributions. For a higher-rate taxpayer, this effectively reduces the cost of a £100 investment to just £60.

Sipp schemes also give investors a wide array of investment choices including the ability to invest in UK and overseas shares, commercial property, investment trusts, unit trusts and Oeics and, from next April, shares listed on Ofex, London’s third tier market. However, this week’s news that residential property and exotic investments such as fine wines will not attract the tax perks of pensions will stymie most investors’ plans.

Sipps vary in levels of sophistication, cost and flexibility. “No-frills” Sipps are offered online. These cut administration costs and allow investors to take more control over their pension. However, in many cases, this type of scheme only allows limited investments in UK equities or funds such as unit trusts.

More comprehensive and expensive Sipps tend not to be administered over the internet. They are less restrictive and allow investors to shelter commercial property and quirkier investments. They can cost as much as £750 to set up and from £200 to £2,000 a year to manage. Predictably, Sipps that shelter properties are the most expensive.

Sipps can only be set up by a professional trustee and an administrator. They act as custodians and help reassure the Inland Revenue that the tax breaks conferred on the assets in the pension “wrap” are being supervised properly.

Like traditional pensions, investors can start drawing an income from their Sipp from age 50. (In 2010, the earliest age at which income and other benefits can be taken will rise to 55.) You can also take up to 25 per cent of the money accrued in the Sipp as tax-free cash from the age of 50. Under the current regime, you have to start drawing an income before you can take tax-free cash. But, from April, you will be able to take your tax-free cash entitlement, regardless of whether an income is being drawn.

What are the benefits?

The range of investment opportunities in Sipps is far broader than the options available in traditional pensions, so many investors are likely to convert personal pensions to Sipps come A-Day.

Stamps, fine wines, racehorses and classic cars may not make sense as investments under the new pensions rules, but there are still other investment freedoms worth having. Sipps will provide bigger opportunities for generating an income in retirement as they will allow investors to choose from a wider range of funds. Investors can also invest directly in gilts (UK government bonds) and commercial property. Under current rules, Sipps can borrow up to 75 per cent of the value of a commercial property to fund a purchase. However, from April next year, borrowing in a Sipp will be limited to 50 per cent of the total value of the fund. You can also use a Sipp to streamline the management of your retirement funds as pension contributions from various sources can all be consolidated into just one Sipp.

What are the possible drawbacks?

One concern is the lack of regulation of Sipps, raising the possibility of misselling or that investors will have no redress for poor advice. The FSA will not regulate Sipps until 2007 at the earliest. If you are being advised on a Sipp it would make sense to seek out an adviser that treats Sipps as if they are a regulated activity.

The Treasury has released a paper proposing that only companies that are regulated for offering pensions should establish Sipp schemes.

How do I choose a Sipp?

Any good independent financial adviser should be able to direct you to a Sipp that fits your financial needs. If you are uncertain about whether you want to take the plunge and enrol in a full Sipp, some providers offer “deferred” Sipps, which can be transformed into full-blown Sipps at any point, triggering higher fees.

The most popular Sipps are basically broad investment products that offer access to a supermarket of funds. They charge nominal fees upfront and broker fees when shares are bought or sold.