Double benefits of a Sipp retirement pot

As returns on investments and cash savings continue to fall, investors are placing more value on the tax relief available to assets held in pensions.

Advisers say that a growing number of clients, especially those nearing retirement, are transferring money from personal savings accounts and employee pension schemes into self-invested personal pensions (Sipps).

Sipps offer flexible contributions and allow pension savers to take their retirement benefits in the most tax-efficient way to suit their circumstances.

“As we draw nearer to the end of the tax year, we are seeing increased levels of annual contributions as investors look to take advantage of this year’s relief,” says Henry Catchpole, chief executive of Suffolk Life, a Sipp provider.

Pension experts say that investors close to retirement, who are most vulnerable to pension shortfalls, are seeking to ensure that their pension contributions are made in the most tax-efficient manner and are willing to lock up their money in order to achieve this.

Investments in a Sipp cannot be accessed until the investor reaches 50, and from April 2010 the age limit will rise to 55. But, according to Malcolm Cuthbert, managing director of financial planning at Killik & Co, the tax relief available on money invested in a Sipp more than makes up for this inconvenience.

Contributions made to a Sipp automatically receive basic rate tax relief, boosting the investment by 20 per cent. Higher rate taxpayers can claim an additional 20 per cent on their tax returns, meaning that money paid into a Sipp receives a 40 per cent tax break.

Pension rules decree that investors can pay in 100 per cent of their earnings, up to a maximum of £235,000, each year and can obtain higher rate tax relief on the entire amount. But advisers say it is possible to pay more than £235,000 in any tax year, by altering the input periods.

Paul Garwood, director at Smith & Williamson, the accountancy firm, says these arrangements are common and it is not difficult to arrange a change in the pension input period, although trustees must be notified.

Tax relief is provided on pension contributions at the end of the tax year, but the annual allowance limit-ation concludes at the pension scheme year-end. Most pension scheme year-ends will be on April 5, but there is scope to move this date.

For example, if in the 2008/09 tax year an investor pays in the maximum annual contribution of £235,000 at the end of February, he or she can request that the pension scheme year concludes at the end of February, rather than the start of April.

In March, the investor can then add a second contribution of £245,000 – the maximum allowance for the 2009/10 tax year – into the Sipp. Although the input is calculated for 2009/10, the tax relief will be paid in the year the contribution was made, which was 2008/09. In this case, the saver would get tax relief on a total of £480,000 in the 2008/09 tax year.

For those in employment, it is possible to make pension contributions into a Sipp through salary sacrifice or bonus waiver scheme, which can be more tax efficient as the relief is immediate. John Moret at Suffolk Life says people in share save schemes can roll the shares into a Sipp and avoid stamp duty.

Such arrangements offer a 90-day period in which to exercise the option and it can be done “in specie”, meaning the shares do not have to be encashed first.

Because of all the tax reliefs, a higher rate taxpayer can generate a pension fund of nearly £4,700 with £885 worth of shares, even if the shares do not rise in value, says John Lawson, head of pensions policy at Standard Life. If they do rise, the returns will be even better. This means shares could fall by 81 per cent before an investor who put them in their Sipp lost out.

Each individual has a lifetime allowance for total pension contributions, which for 2008/09 is £1.65m. This rises each year until it reaches £1.8m in 2010. The pension fund grows tax-free on both income and gains, except for corporation tax which is already deducted from UK dividends.

At 50, savers can take out a quarter of their savings as cash, tax-free. For savers who are higher rate taxpayers, and who would therefore pay 40 per cent tax on savings and income, this money represents an overall gain of 10 per cent on savings. It is common for investors to transfer cash into their pensions just before turning 50 and take it out tax-free immediately afterwards, says Lawson. After the tax-free cash has been taken, further income is taxed, and savers who have retired and have no income can add just £3,600 to their Sipp each year.

Sipps can also be used by investors drawing down income from their funds to control the level of income tax they pay. Unlike an annuity or final salary pension, which will pay out a fixed amount each year, Sipps allow scheme members to choose the income they take out.

The ability to switch on and switch off income each year means that other taxable events, such as the receipt of dividends or the encashment of an investment bond, can be managed without exceeding the higher rate tax threshold, points out Lawson.

But some pension experts fear that the government could soon reduce the tax relief on pensions. Savers considering making a contribution to a Sipp are therefore advised to act now.

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