SIPPs Explained. How to plan for your retirement

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1 SIPPs Explained How to plan for your retirement

2 SIPPs Explained Nearly a million in the UK have a SIPP but what are they? What benefits do they provide and do they live up to the hype? In this guide we will break down exactly what a SIPP is, the benefits and flexibility they provide and whether it could be the right product for you. To find out more please call our New Client Team on We pride ourselves in being a relationship firm. Each client has their own dedicated Broker, who acts as the single point of contact to provide award winning investment advice and trade execution, as well as handling any administrative matters. We provide our clients with wealth planning, investment management and advisory stockbroking services with access to allmajor asset classes equities, fixed income bonds, commodities and currencies - in over 30 markets worldwide. Independent research, from our team of analysts, who are frequently quoted in the press, is available to all our clients along with our Daily Note by and our quarterly magazine Confidant. Killik & Co, your partner for investment and wealth advice. What is a SIPP? A SIPP is a Self Invested Personal Pension created to offer you greater control of your pension arrangements. It is a personal tax wrapper and works in the same way as a personal pension or stakeholder pension in terms of tax benefits and contribution limits. The key advantage of SIPPs is the wide range of investment choice they can provide. Traditionally, personal pensions were provided by insurance companies and were limited in the range of funds they offer. However, a SIPP can pick from many different investments and types of investment across the whole market both in the UK and globally. Another advantage of SIPPs is the flexibility they provide when coming to take retirement benefits, with the option to go into drawdown (drawdown involves taking up to 25% tax free cash and drawing an income from the remaining 75%) or taking a one of lump sum comprising of both a tax free and income element rather than having to purchase an annuity. More and more insurance companies are now offering SIPPs however these can be restricted offerings without the wide investment choice Killik & Co offer. What are the tax advantages? As with personal pensions, SIPPs have the same basic tax advantages: Tax relief on contributions Fund growth is tax free (except the tax credit on UK equity dividends, which cannot be reclaimed) 25% of funds can be paid out tax free when taking benefits Tax relief on contributions Allowable pension contributions receive tax relief. How this works in practice is that contributions are paid net of basic rate tax and HMRC then pays the pension provider the basic rate tax rebate direct into your pension. So for every 80 you pay into your pension plan, HMRC then tops up your payment by 20 (up to 3,600 gross pa or 100% of your net relevant earnings, whichever is the greater). If you pay tax at 40% or 45% income tax then the additional tax relief of either 20% or 25% may be allowed through your tax return and will either result in a reduction to your tax bill or repayment to you if you have overpaid. Tax rules may change at any point in the future. Tax Free Fund Growth Generally investment returns are free of Capital Gains Tax and Income Tax therefore your investments grow more quickly. The exception to this is the dividend tax credit of 10% which cannot be reclaimed and some withholding taxes which operate in different countries. 2 SIPPs explained

3 Tax Free Lump Sum When you decide to take benefits from your SIPP you have the option to take a tax free lump sum of 25% of the current value of your plan. Although it is prudent to note that the tax treatment of investments can change with future legislation. Who can set up and contribute to a SIPP? There is no minimum age limit to become a member of a pension scheme. The question is what contributions attract tax relief? If an individual is a UK relevant individual and under the age of 75 then tax relief can be claimed on payments of up to 100% of UK relevant earnings or 3,600 if higher. This is subject to an override limit called the annual allowance. However, anyone with no income, even a child, is entitled to contribute 3,600 to a SIPP and with HMRC contributing 720 the net cost is only 2,880. Those over 75 can contribute but can t claim tax relief. A UK relevant individual is defined as someone who: Is resident in the UK at some time during that year with earnings subject to UK tax or Was resident in the UK both at sometime during the 5 tax years immediately before that year and when the individual became a member of the pension scheme, or They, or their spouse or civil partner have, for the tax year, earnings from overseas crown employment subject to UK tax. Relevant UK earnings generally include: Employment income Bonuses Benefits in kind Self employment Partnership profits They do not include any of the following: Investment income Rental income Pension income The annual allowance is ordinarily 40,000 and is the maximum tax relievable contribution that can be made in any tax year. However, it is possible to carry forward unused relief from the three previous tax years. To be eligible for tax relief there must be sufficient earnings in the year of payment to support the contribution amount. However different rules will apply to individuals that access their pension funds for the very first time after April 2015 and the contribution level will be at a reduced amount of 10,000 pa. In addition there is no carry forward option. How to start a SIPP There are 3 ways to start a SIPP: 1. By paying in contributions 2. By selling investments and repurchasing them within the SIPP 3. By transferring in any existing Pension Plans you may have. A combination of these is possible too. As people progress through their working life and change employment they also join a different pension plan with each employer. These plans can vary from an Occupational Final Salary Scheme to a Group Stakeholder. The benefits of these plans vary significantly and if you are considering a SIPP then this is also an excellent time to review your existing pension provisions to see if there is any benefit to transferring. An additional benefit of transferring your existing pensions into a SIPP means you can see your entire pension provision in one place. This can help you and your Broker to choose investments as you can easily see all current investments in one statement. There can, of course, be risks involved with transferring out of an existing pension scheme. These can range from the loss of funds through a transfer penalty to the loss of guaranteed benefits available under a final salary scheme or a guaranteed annuity rate. The subsequent investment growth therefore required in the SIPP may be higher to outweigh these. There is never any guarantee that the investments within the SIPP will match this required performance, or indeed outperform your existing pension. Because of the risks involved in this complex area professional advice should be taken. Options at retirement The traditional option at retirement has been to take 25% tax-free as a lump sum and then buy an annuity with the remaining 75%. You can take your pension benefits from age 55. Everyone can take 25% of their fund as a tax-free lump sum but the remainder can be taken in different ways: Lifetime Annuity In exchange for your pension fund you can buy an income for the rest of your life. Two different types of annuity: Conventional - Where income can be fixed, inflationlinked, increased by a set percentage each year, or Investment Linked - Where income is linked to underlying investment performance. Annuities can be bought on a joint life or single life basis with different guarantees in place. Other options available through a SIPP A SIPP provides you with other options: Drawdown Phased Retirement Uncrystallised Funds Pension Lump Sum (UFPLS) SIPPs explained 3

4 Drawdown The main issue with Lifetime Annuities is the fact that once purchased you lose access to your pension fund. Drawdown provides you with an income but still leaves you with access to your pension, therefore leaving you in control of your investments. As you are still invested there is a risk that the income being taken, combined with poor performance, will be a drain on the fund. Phased Retirement When taking your retirement benefits there is no requirement to convert your entire pension at one time. Pensions are generally segmented and you can take them in slices over a period of time. This can be more tax efficient and can be designed to work with your financial assets. Uncrystallised Funds Pension Lump Sum (UFPLS) As an alternative to Drawdown, you are able to take a single or series of lump sums from the uncrystallised element of SIPP, without actually having to designate them for drawdown first. The first 25% of the amount paid is tax free, with the balance taxable as pension income. The balance will in most cases be taxed on an emergency tax code which is likely to mean an incorrect tax amount is initially deducted. Risks There are a number of ways that you can access your benefits and there are different risks involved with the decisions that you make. It is important to consider all of the options that are available before you make a decision about your retirement choices. Failing to do so could mean that there is a more suitable product for you on offer, which you have not considered. Therefore we would always recommend you take financial advice before proceeding. Alternatively, we would suggest visiting Pension Wise for guidance ( In particular, accessing your pension benefits via Flexi- Access Drawdown and UFPLS can have specific tax implications because the money is being removed from a tax advantaged wrapper and it could affect your marginal tax rate. This can then impact your access to meanstested benefits and if you have debts elsewhere then your creditors may be able to make a claim against the monies you have removed from your pension. Another considerable risk with Flex-Access drawdown is the possibility of the funds underperforming and therefore you receiving less income (or even no income in extreme circumstances) than would have been the case with a pension annuity. We would urge you to take advice. SIPPs are not a risk-free product. Your capital may be at risk due to the investments held within this wrapper. Individual investments are subject to fluctuations and you may realise less then sum invested. The tax treatment of investments may also change with future legislation. Investment choices Using a SIPP wrapper rather than a personal pension significantly opens up the investment options available. A personal pension is limited to the funds offered by an insurance company whereas a SIPP can invest in any of the following: Cash Equities (UK and foreign) Gilts and other fixed income instruments Unit Trusts and OEICS Hedge Funds Investment Trusts Real Estate Investment Trusts (REITs) Commercial Property & Land Futures and Options Traded Endowment Policies Gold Bullion This wide variety of options gives you the opportunity and flexibility to have a truly diversified portfolio. However, you should note that SIPPs are not risk-free products and your capital may be at risk due to the investments held within this wrapper. Case Study Examples 1) Transferring your shares into a SIPP Allan Jones, 49, a Company Director of a listed company and a 40% tax payer, receives tax relief on the shares he owns by transferring them into a SIPP. Mr Jones accumulated shares in his own name over several years and at 49 he decided that to make up a significant pension shortfall he would make an in-specie (using shares rather than cash) contribution of 24,000 worth of these shares. The shares are, effectively, his contribution to his pension. This results in a total pension contribution of 30,000 ( 24,000 worth of shares plus 6,000 in cash from HMRC as tax relief on the contributions). Mr Jones will also receive another 6,000 from HMRC after making the declaration of this pension contribution in his tax return. The net result is that Mr Jones continues to effectively control the 24,000 worth of shares, but they are now in his SIPP. In addition the SIPP has a further 6,000 of cash contributed by HMRC which could be used to buy another 6,000 worth of his holding of the same shares, or another investment altogether. Furthermore, as a 40% rate tax payer, he also saves himself a further 6,000 of higher rate tax. So by switching a 24,000 investment into his SIPP he has generated 12,000 of new cash and yet still effectively controls the same number of shares. 4 SIPPs explained

5 2) How consolidating your pension plans can benefit you Jane Bishop, aged 43 and a 40% rate tax payer, had just started a new job and decided that this was a good opportunity to review all her pension plans. Like most people Jane, after working for 20 years, had several different jobs which had ended up giving her a mixture of different types of pension arrangements, including a company (or occupational) pension and several different pension plans. Her objective was not only to understand what these plans were worth but also whether she was on target to stop working at the young age of 55 on an income of 35,000 per annum (in 12 years time). Jane took advice from a Killik & Co Wealth Planner who established that she had the following: A money purchase occupational pension plan valued at 66,200 Personal pension plans valued at a total of 210,000 There were no disadvantages to moving these plans, and their performance had been lacklustre so it was agreed that all would be transferred to the Killik & Co SIPP. The SIPP was felt to be more appropriate than a personal pension because Jane was keen to invest directly in a portfolio of good quality equities, bonds and funds. She knew that to reach her early retirement objective that she had to take more risk with her investments. The total transfer value added up to 276,200. But to achieve Jane s target of 35,000 per annum in 12 years time it was agreed that she would increase her annual contributions to the SIPP to 20,000 gross or 12,000 net (after tax relief at 40%). Assuming 4% real growth, her existing pensions would be worth 442,205 in today s money, adjusted for inflation. At the same time, her future contributions, on the same basis, would be worth 310,000, making a total of 752,205. To achieve her income expectation from this amount of capital would require a yield of 4.6%. This could be achieved either through a pension annuity or though the use of a drawdown plan. If the latter, she might decide to mix some good quality equities with corporate bonds, to give her some protection against inflation. Calculated as follows 276,200 x 12 years x 4% compounded real rate growth* = 442,205 *7% annual growth less predicted 3% annual inflation = 4% real rate growth. The required fund value was 750,000 so Jane is underfunded by 310,000. An additional 20,000 per annum x 12 years x 4% = 310,000 fund value This additional funding and her existing arrangements will enable Jane to retire at 55 on 35,000 per annum. 3) Investing in a pension for children? John Elliot, a doting Grandfather, wanted to help his grandchildren have a sound financial future he also knew how powerful a weapon compound interest could be over a long period of time. With advice, John decided to contribute 2,880 every year for 10 years to a Self Invested Personal Pension (SIPP) for each of his grandchildren from birth this is grossed up to 3,600 with basic rate tax relief from HMRC. This very generous gesture cost him 28,800 per child but could end up generating a pension fund of 390,000 in today s money, adjusted for inflation. Assuming good quality Corporate Bond yields of around 5%, this would be enough for them to retire at 65 on an income of 20,000 pa without ever having to make any contributions themselves. Alternatively they may wish to pay off some or all of a mortgage at age 55, by withdrawing 25% of the value tax free, and take a lower income in retirement. For John a SIPP was more appropriate than a personal pension because the investment choice is much greater. He chose to invest directly in growth stocks for his grandchildren thinking that in order to produce the average 7% pa he was seeking, he would need to invest in higher risk investments. Calculated as follows 3,600 x 10 years x 4% compounded real rate growth* = 45,000 *7% annual growth less predicted 3% annual inflation = 4% real rate of growth 45,000 x 55 years x 4% real rate of growth = 390,000 in today s value which could produce an income of 20,000 pa. 4) Making a lump sum contribution as well as regularly saving into a pension Alison Hart works for a successful hedge fund which is not only producing very useful profits but is also rewarding its talented Manager handsomely. Alison had lived for some time out of the UK, working in Dubai and the UAE. As such she had made little or no pension provision. Her knowledge of various companies gives her some insight into which ones might be good investments in the long term. Now back in the UK (and paying UK income tax for the first time) Alison establishes a Killik & Co SIPP and decides to contribute 32,000 which attracts income tax relief. This entitles her to basic rate tax relief of 8,000 which is paid directly into her SIPP by HMRC, increasing the cash available for investment into the SIPP to 40,000. On completion of her tax return she receives another 8,000 higher rate relief, payable to her. This means that by subscribing a cash sum of 32,000 into her SIPP, she has a SIPP worth 40,000 and an additional 8,000 in her bank account. Alison plans to make the maximum contribution her SIPP over the next five years to enable her to develop a significant pension fund. Conclusion SIPPs will allow you to take greater control of your retirement planning. They give you freedom of choice to make your investment decisions and give you the flexibility to decide how you want to take your retirement benefits. If you want to discuss your retirement planning in more detail please contact the New Client Team on SIPPs explained 5

6 Killik Explains Educational Video Series It has always been our philosophy that when it comes to investment, knowledge is everything. We have therefore committed to enhancing our clients understanding with a series of educational videos called Killik Explains which covers a broad range of investment topics. We highly recommend that all Killik & Co clients view arguably the two most important videos - Lifetime Savings: The Risks and Why Investors Must Diversify. from Tim Bennett It is important that you understand that there remains risk with all investment and you may not get back the original capital invested. The value of your investments may fall as well as rise, and the past performance of investments is not a guide to future performance. The tax treatment of investments may change with future legislation. Call a Broker today: info@killik.com Killik & Co is a trading name of Killik & Co LLP, a limited liability partnership authorised and regulated by the Financial Conduct Authority and a member of the London Stock Exchange. Registered in England and Wales No OC Registered office: 46 Grosvenor Street, London W1K 3HN. A list of partners is available on request. Killik Offshore is the registered Branch of Killik & Co LLP in the Dubai International Financial Centre ( DIFC ), a trading name of Killik & Co LLP and is an Authorised DIFC Branch regulated by the Dubai Financial Services Authority ( DFSA ). Telephone calls may be recorded for your own protection and quality control. You should be aware that the value of investments and the income from them may vary and you may realise less than the sum invested. Past performance of investments is not a guide to future performance. The tax treatment of investments may change with future legislation. The charges and commissions contained in this brochure are current at the time of publication but are subject to change. Please ask for a current copy of the Terms and Conditions. This financial promotion has been approved by Killik & Co. SIPP EXPLAINED 04.16