I have already provided an overview of pensions in general here, and so now I will expand upon the SIPP or Self Invested Personal Pension in more detail.
As a reminder, pensions are a form of long term investments designed to help you save money for later life, and be able to generate an income during retirement, that should last as long as you do, and hopefully, still have a little leftover for your family.
Pensions have very favourable tax treatment compared to some other forms of savings, which means your pension “pot”, is allowed to grow by a combination of factors.
Firstly, you get a basic rate tax relief boost added to your pension pot from the Government, this adds £25 for each £100 invested.
Secondly, your capital can grow free of capital gains tax for as long as your money is in your pension pot.
And thirdly, there is also no tax to pay on dividends or interest from shares and bonds within a SIPP.
There is also a fourthly, for anyone in the higher earners tax band, in that you can also claim a further tax rebate on your self-assessment tax return.
And, as if that’s not all, pension investments also benefit from the magic of compound interest, as they are invested for so long in the markets.
A SIPP pension isn’t an investment as such, it is a vehicle for investments in much the same way as an ISA is also a vehicle for investments. The big difference is that you can get your money out at any time from an ISA, but once it’s put into a pension, you cannot get at it until at least 55, rising to 57 in the next few years.
This lack of access can be quite off-putting to younger investors, but as we have mentioned numerous time before, the earlier you start, the less you will have to commit yourself, and the more you will have in the end.
SIPPs can be used to acquire most of the investments and assets previously described on the website, and to shelter them from the taxman.
Your SIPP can contain any number of assets you choose, such as individual stocks and shares, equity funds and trusts, corporate bond funds, high yield bond funds, property funds, gold funds, commodity funds, ETF’s and so on.
The “self-invested” part of your pension is exactly that, you can decide yourself exactly what is invested in your pension, and what is not.
Here is a quick overview of some of the main advantages and disadvantages of SIPPs:
You can choose your own investments amongst a universe of thousands.
You can invest both monthly and with one-off payments.
You can enjoy at least 20% and up to 45% tax relief on your investments.
There are no age restrictions of when you can open a SIPP.
You cannot access your SIPP until you are at least 55 years old.
You can pay into a SIPP until the age of 75.
You can withdraw up to 25% of your SIPP fund tax-free (upon reaching the minimum pension age).
SIPPs offer flexible withdrawal options.
You can pass on your SIPP tax-free to your family.
You can take control of what you invest in if you want to.
There are limits on tax relief. The current maximum contributions you can earn tax relief on are either 100% of earnings or £40,000.
Your money is locked in until the age of 55 or older (yes it’s also an advantage).
You could make poor investment decisions by self-managing.
There is a cap on the maximum size of your total pension pots of just over £1m. Anything above this is heavily taxed.
Should you open a SIPP?
You will have probably recognised that there are some considerable advantages when investing via a SIPP, as well as one very obvious disadvantage, in that you cannot get at your money for a long time.
Owning a SIPP puts you in control of one of your retirement plans, and is an essential part of your overall strategy, for achieving financial independence.
When exactly you choose to open a SIPP is up to you, although you can try and ask your parents or grandparents to set one up for you, and even contribute if you are a young investor, just to get you started.
Obviously, there are many other demands on a person’s income, and I can well appreciate that setting up a SIPP, as well as already having a workplace pension to contribute into, is probably not exactly top of your things-to-do list.
Nevertheless, when you gain a bit more experience with investments and asset classes, and also have just a little extra spare cash, it will be well worth the effort in the long run, if you can set one up and contribute a little and often.
You will thank me for it eventually!