Whether you’re a young saver prepared to take on more risk, or a retiree who doesn’t want to trade their nest egg for an annuity, self-invested personal pensions (Sipps) are tax-efficient vehicles which put you at the controls.
Also known as DIY pension schemes, Sipps can be used to invest in any number of assets approved by HMRC, from exchange-traded funds and unit trusts, to commercial and intellectual property. They are the preferred method for pensioners entering drawdown, and enjoy tax relief like any other pension.
If you’re confident being your own guidance system, here are five ways to boost returns and preserve capital in your personal pension.
UK savers don’t have a particularly strong record when it comes to keeping an eye on their pensions. Indeed, fully £15-20bn of the UK’s investments and savings lie unclaimed, according to an estimate by Hargreaves Lansdown. When you switch jobs, or change address, it is easy to forget about a previous workplace pension, or fail to notify pension providers.
Brits entering work today can expect to hold around nine different jobs during their working lives. And nine different employers is likely to mean nine different workplace pensions to keep track of until retirement.
Sipps are ideal for putting all your accumulated pension pots in one place. Not only does a single pot make your pension more manageable, you are likely to make considerable savings on the fees charged by many different providers. Moreover, the Department for Work and Pensions recently launched a new Pension Tracing Service website to help people track down their lost savings, so consolidating all your pots has never been simpler.
However, you should be sure to check with your provider about any charges involved in transferring out of your policy before the agreed retirement date.
Make the most of tax relief
Earlier this year, the chancellor decided not to implement a flat rate of pension tax relief, so the government will continue to top up savers’ pension contributions at their marginal rate of income tax.
As a Sipp holder, you will automatically receive basic rate tax relief of 20 per cent on any contributions you make, and higher and additional rate taxpayers can claim back even more through their self assessment form. The benefits can be huge. Figures by AJ Bell Youinvest show that a higher rate taxpayer who put £32,000 of their own money in a Sipp would receive an £8,000 top-up automatically, taking the total size of their pot to £40,000. They could then claim back a further £8,000 through self-assessment, meaning that the effective cost of a £40,000 pot would be as little as £24,000.
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Bequeath your pension
Changes which were introduced last year have turned pensions into legacy vehicles for passing wealth down the generations.
Inherited pensions are no longer subject to the 55 per cent death tax. And if you die before the age of 75, you can pass any wealth in a private pension onto nominated beneficiaries tax-free, even if you have already begun making withdrawals. Those beneficiaries – your spouse or children, for example – are then able to choose whether they want to use the money to buy a tax-free income or take it as a lump sum. However, beneficiaries are not nominated automatically; you must give their names to your pension provider.
If you live beyond 75, the money will pass to your beneficiaries tax-free, but they would be liable to pay income tax at their marginal rate when they come to access the savings.
So if you have Isa savings or a second home, it might make more sense to liquidate those assets first so that you can leave as much of your pension to those you leave behind.
Know your allowances
One of the Sipp’s greatest virtues is that investment returns on savings are not liable for income tax or capital gains tax (CGT), and like any other pension, you can still take 25 per cent as a tax-free lump sum when you reach 55.
For those with pension savings nearing the £1m mark, it is important to take advantage of other tax-efficient methods to ensure the cumulative value of your pensions doesn’t exceed the lifetime allowance, which is £1m for the 2016-17 tax year. After this, you will face a tax charge of 55 per cent on the excess when you come to withdraw it.
Regularly monitoring projected growth in your Sipp, and using up your other tax-free allowances, can stop you from being stung. You can currently shield £15,240 from tax each year in an Isa, for example, and this limit will grow to £20,000 from April 2017.
Even outside of the pension and Isa wrappers, you only have to pay CGT on realised gains of more than £11,100 in a tax year, or £5,500 for trusts. Under the new dividend tax regime, everyone can earn £5,000 a year in dividend income tax-free.
Comparing the value of Sipps is difficult, so it is worth reading the small print or contacting platforms directly so you can make an informed decision.
Low-cost “execution only” platforms don’t tend to have set-up costs, but charging structures can be complex. The costs you pay will depend on your platform, any advice you receive or research you can access, the type of assets you hold, how often you trade them, and whether they are managed actively by a professional.
Platform charges will be higher than those of an Isa when you start exiting your investments to take your money through drawdown, and they may be subject to ongoing charges every year after you start withdrawing money.
This article appears in the May edition of City A.M.'s Money magazine, which will be distributed with the paper on Thursday 26 May.