A self-invested personal pension (SIPP) is similar to a conventional personal pension in as much as it received payments and transfers from other arrangements with the aim of providing pension benefits.
Firstly, as the name implies, a SIPP does not have the investment choice of only one product provider. It is, in effect, an empty box, or wrapper, which can contain any investment approved by HM Revenue & Customs for pension purposes. An important point to note, however, is that by using a SIPP wrapper they are not tied to the products of one pension provider but are free to choose the most suitable investment medium for their circumstances.
Secondly, a SIPP arrangement with pension fund withdrawal offers the facility to take retirement benefits by means of drawing income directly from the fund, rather than having to buy an annuity. This is a particularly important facility because it allows you to remain invested whilst drawing retirement income and has important consequences when considering estate planning and death benefits. Furthermore, the investment flexibility inherent in the plan, coupled with the time available until an annuity is purchased, gives the plan the opportunity for some significant capital gains.
Benefits can be taken from age 50 (55 from 6 April 2010) and 75. You do not need to stop working to take benefits under the plan.
HM Revenue & Customs may permit certain exceptions to the lower age limit if you are in serious ill health.
The legislation allows a retirement income to be drawn from the plan without having to purchase an immediate annuity. This offers the ability to choose a level of income between nil and the maximum amount according to the Government Actuary's Department's tables (GAD limits). This offers the ability to match income more closely to needs. The withdrawals can be sufficient to provide income in a joint life situation negating the need to have to buy an expensive joint life annuity.
There is opportunity to take some, or all, of the tax-free lump sum at outset and then to draw sufficient taxable income whilst allowing the remaining fund to continue to grow in a pension fund environment. Any entitlement to tax-free lump sum must be taken before age 75 or it will be lost.
Control over investments
With a SIPP income withdrawal plan you can retain control over the investment by selecting where to invest the funds and also to switch between asset classes. It is vital that income can be withdrawn from selected, individual asset classes with the opportunity to switch into annuities when appropriate. With the alternative route of buying a conventional pension annuity, the underlying investment is in UK long-dated gilts or debentures and there is no choice or control once the original investment decision is made.
Choice of annuity purchase
Under the SIPP income withdrawal plan you can defer annuity purchase. This means that annuity purchase can be deferred until rates are more favourable and that the annuity purchased can, if necessary, be spread over a long period of time (phased annuity purchase).
You are not tied to one particular rate and as circumstances change (possibly joint life to single life because of bereavement) then an appropriate annuity can be purchased at the correct time.
Death benefits
The rules that define what happens to you remaining pension funds on death are not complicated, but there are lots of them.
They differ depending on whether the particular pot of money is pre or post pension date. If you think of the pension fund as 1000 identical pensions (arrangements) each with its own attachment of tax-free lump sum entitlement, those arrangements from which the tax-free lump sum has not been taken and where withdrawal of income has not commenced are pre pension date. Those arrangements where the tax-free lump sum has been taken and you are drawing an income are post pension date arrangements.
There are various permutations as follows: -
Pre pension date arrangements
Entire fund paid out as lump sum under 'expression of wish' to heirs without taxation.
Post pension date arrangements
Death in unsecured pension (before age 75)
With dependant at date of death
The dependant would have the choice of: -
- Receiving the fund subject to 35% tax charge as above.
- Continuing taking an income payment.
- Purchasing an annuity.
- A combination of all of the above.
Without dependant at date of death
Nominated heirs would receive the fund subject to 35% tax charge.
Death in alternatively secured pension (on or after age 75) Surviving dependant at date of death
The remaining fund must be used to provide survivors' pensions for any surviving dependant(s). This can either be done by income drawdown or by buying an annuity. Once all remaining dependants have died, any remaining funds are then used in accordance with the rules for death in unsecured or alternatively secured pension, depending on whether the dependant is above or below age 75 on death.
No surviving dependant
If there are no surviving dependants the funds on death can be transferred to other members of the same pension scheme (transfer lump sum death benefit) or to a charity (charity lump sum death benefit).
Inheritance Tax
Pension death benefits will not normally generate an IHT liability on death before age 75.
On death on or after age 75 whilst in alternatively secured pension (ASP), the remaining ASP fund must be used to provide pensions for any surviving dependants of the pensioner. Dependant means widow(er), civil partner or other financial dependant. In these circumstances, there will be no IHT liability until their subsequent death. If there is no surviving dependant, the ASP fund can either be paid to charity, which will be exempt from IHT, or reallocated to other members of the pension scheme as a transfer lump sum death benefit, which will be chargeable to IHT as if they were part of the pensioner's estate.
Investments
Under traditional pension arrangements, the choice of investment manager is decided for you normally by the financial institution providing the personal pension which also manages the investment. A SIPP unbundles the administration from the investment management. The assets of the pension fund will be held on your behalf by the trustees. You will, however, be in control of where you money is invested.
Registered pension schemes can, in theory, invest in almost any kind of asset. However, there are controls over pension scheme investment that restrict investment options in practice.
- Crucially, where investment-regulated pension schemes (like SIPP or SSAS) invest in taxable property (see below) both the member, and the scheme, face heavy tax bills.
In addition to this key control:
- There are limits on some other kinds of investment - designed to encourage sensible investment behaviour and reduce the chance of abuse.
- Pension scheme trustees have a duty to invest sensibly, in line with the aims of the pension scheme.
- Investment transactions have to be conducted on a normal commercial basis - and non-commercial, or value stripping, transactions may result in tax bills.
- Pension schemes are taxed on trading income.
- And last but not least, pension scheme trustees and product providers limit the investment options available under some pension schemes or products. Greater investment flexibility is only likely to be allowed under more specialist vehicles like SIPP or SSAS.
Finally, before we move on to look at the investment rules in a bit more detail, there are a couple of other points worth noting:
- There are some differences between the investment rules for occupational pension schemes (OPS) and those for personal pension schemes (PPS).
Some investments are more tightly regulated or subject to stricter limits now than they were before (although investments legitimately held before 6 April 2006 can be kept).
Taxable property - SIPP & SSAS
Some kinds of investment are classified as taxable property if they are held by investment regulated pension schemes.
Investment-regulated pension schemes are, in broad terms, pension schemes where a member (or someone related to a member) can influence how the scheme assets are invested. For example, SIPP and SSAS are investment-regulated pension schemes.
Taxable property means:
· residential property, or
· tangible moveable property.
Tangible movable property means assets that can be touched and moved. Examples are:
· Works of art
· Jewellery
· Antiques
· Gem Stones
· Postage Stamps
· Autographs
· Fine Wines
· Vintage Cars
· Yachts
Gold bullion is not treated as tangible moveable property.
Other kinds of pension scheme can invest in taxable property. However, if investment regulated pension schemes like SIPP or SSAS buy taxable property, there would be heavy tax bills:
- the member would have to pay an unauthorised member payment tax charge of 40% of the value of the taxable property
- the scheme would have to pay a scheme sanction tax charge of 15% of the value of the taxable property
- if the cost of the asset is more than 25% of the member's fund value, the member would have to pay a further unauthorised payments tax surcharge of 15% of the value of the taxable property
- the scheme would have to pay tax on any income or gain from the asset.
To cap it all, if more than 25% of the scheme funds were invested in taxable property the scheme could be de-registered. This would mean a further tax bill for the scheme of 40% of its total assets.
In practice, this makes it very unlikely that SIPP or SSAS providers will allow investment in taxable property.
Investment-regulated pension schemes can invest indirectly in taxable property without a tax charge - so long as the investment is made via a genuinely diverse commercial vehicle. For example, indirect investment in the residential property sector will be available using vehicles like real estate investment trusts (REITS).
There are, however, controls to stop abuse via indirect investment (for example, by using a SIPP to buy a controlling interest in a residential property investment company).