Do it yourself: the joy of SIPPs
Ian Cowie
If you think pensions are boring, how exciting do you think poverty in old age will be? I only ask because conventional attitudes to this problematic topic are not just dangerous but also out of date. Most people know that failing to save will not prevent them growing old. Fewer realise how recent rule changes have removed many of the more rational excuses for shunning pensions.
First among these is distrust of insurance companies. The age of deference ended long ago and one unexpected casualty was the with-profits fund. People are no longer willing to buy financial products they do not understand simply because a man in a suit says it will be good for them.
If a clever salesman does succeed in clinching such a deal, consumers are more likely to seek compensation than sit back and hope for the best. Equitable Life had more actuaries than God but its attempt to mystify pension savers by redefining the meaning of the word ‘guarantee’ ended in disaster. The House of Lords insisted on a plain English interpretation of what ‘guaranteed annuity rate’ meant on all those policies promising savers an income for life which, as it turned out, Equitable simply could not afford to deliver.
More recently, pension savers have been allowed to see exactly where their money goes and the old compulsion to spend at least three quarters of your fund at retirement on an annuity has been substantially eased. The most advanced form of these schemes which put savers back in control are called Self-Invested Personal Pensions or SIPPs.
You can put shares, bonds, commercial property, unit or investment trusts, exchange-traded funds and guaranteed products into a SIPP. In fact, you can put almost any asset into this form of tax shelter — except residential property. The government foolishly raised hopes that even this would be allowed before dashing the dream just before SIPPs hit the mass market two years ago.
Heavens, you can even leave the money in risk-free deposits and still boost its value by a quarter for most people — and by two thirds for high earners — through the usual tax reliefs. Like any other pension, contributions to SIPPs are grossed up to the saver’s highest rate of income tax. So it currently costs basic-rate taxpayers £780 to add £1,000 to their fund before costs (and there are no initial costs on stakeholder schemes, for example), while top rate taxpayers can achieve the same effect by putting in £600. By the way, one unintended consequence of the reduction in basic-rate income tax from 22 per cent to 20 per cent due to come into effect on 6 April is that most people will have to pay more to maintain the rate at which they save for retirement. Basic rate and non-taxpayers will have to invest £800 to add £1,000 to any form of pension but top-rate taxpayers are unaffected.
Needless to say, HM Revenue & Customs is pretty careful about keeping a cap on the £17 billion ‘cost’ of pension reliefs in tax income it foregoes. That was why it balked at subsidising the acquisition of holiday homes and more recent plans to use SIPPs as a form of inheritance tax avoidance.
Even so, the maximum limits on how much each of us is allowed to put in are much simpler than they used to be. Instead of rising percentages of income you could invest at various ages, you can now put in 100 per cent of earnings up to £225,000 — whichever is less — subject to a lifetime maximum of £1.6 million.
But the fun part is taking the money out. You no longer need to pretend to retire or change jobs before you withdraw capital or income from these savings after you reach 50 years of age (due to rise to 55 in 2010).
For the first time, you can take up to a quarter of the fund as tax-free cash from all types of pension; including additional voluntary contributions (AVCs), freestanding AVCs, and opt-outs from the old State Earnings Related Pension Scheme once known as Serps — now called State Second Pension (S2P).
That last change is a windfall nobody expected and which affects an estimated £100 billion of savings. Formerly, everything in AVCs and S2P opt-outs had to be used to buy an annuity. Now you can use the cash for whatever you like — to pay off the mortgage or buy a boat.
True, an unholy alliance of HMRC and life companies are clinging to the idea that savers who reach 75 years of age should use remaining pension funds to buy an annuity — and there are tax penalties for nonconformists, although not quite compulsion. Recent pension reforms in general and SIPPs in particular still represent an enormous extension of consumer choice.
The price of pension tax reliefs used to be an almost total loss of control over your savings. You were also obliged to take a leap of faith in the life companies. Now do-ityourself pensions mean neither of those worries need apply; that’s the joy of SIPPs.
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