invested personal pensions (Sipps) are an increasingly popular kind of tax-efficient pension scheme. But like all investments, they are not suitable for everyone.
Sipps allow better control over what your money is invested in and investors benefit from increased transparency. Compare this to stakeholder pensions, for example, where you have no control over how your funds are dispersed.
The greater choice that Sipps offer has been lauded, with the option to invest in individual shares, bonds, cash and a range of over 2,500 funds, including exchange-traded funds. They are appropriate for those who want to take an active role in retirement planning since you have to make your own investment decisions. With managed pensions, it is the responsibility of the fund to increase its value; with Sipps you are the only one to blame if you reach retirement with nothing in the pot.
Investors should still be cautious: greater choice does not necessarily translate into lower costs. Fees for stakeholder schemes are capped at 1.5 per cent for the first ten years, and 1 per cent thereafter. But Sipps have many one-off charges - particularly for investing in individual shares, which can cost around £10 per transaction. Fees can add up and, as a percentage of the amount invested, may exceed what investors would pay with stakeholder pensions.
Fees also eat into investment capital, making Sipps better suited for those with larger pension pots or those who are likely to make larger monthly contributions. Patrick Connolly, financial planner at AWD Chase de Vere says that "Sipps aren't appropriate for lownet worth individuals with low-risk appetite and funds less than £50,000." But they are an "appropriate wrapper for those who want additional flexibility that isn't available with personal or stakeholder pensions."
Jason Witcombe of Evolve financial planners, suggests that there are plenty of low-cost alternatives: "Although there will not be the same depth of choice, there are still options, from cash, small-cap companies and even emerging markets," many of which can have fees as low as 0.2 per cent per annum of funds managed.
But Laith Khalaf, pension investment manager at Hargreaves Lansdown, argues that Sipps are accessible to those with modest funds. So long as investors are cautious about fees, "they are not a snobby product" and there are ways to reduce costs. For example, some investments previously carried initial charges of up to 5 per cent of managed funds. But many funds are now waiving these costs to attract new business. According to Khalaf "better funds inevitably charge more. But these are not all that different to your typical stakeholder pension schemes."
Khalaf cites the Invesco Perpetual high-income fund, managed by highly acclaimed manager Neil Woodford, which has a total expense ratio of 1.69 per cent. However, some providers are waiving the initial management fee on this fund, making this star performer an attractive low-cost addition to a Sipp.
An active approach often leads to a narrow asset allocation. Witcombe says that retirement planning should be focused on the long term and that narrow portfolios "typically lack adequate diversification". He recommends adding some low-cost, index-tracker funds to counter this.
Some funds invest in assets that have large transaction costs, like commercial property. These funds can be expensive for fund managers to run, and usually have higher annual management fees. But Khalaf thinks that "there is a place in the market for some expensive funds. Investors should not necessarily shun all of them." Some can offer good value.
Witcombe suggests that you review your Sipp annually. This helps you check whether it is performing against your targets and, if it is not, you can rebalance your portfolio. This helps automate the process and prevents "churning". Additionally, review how much you are contributing to your retirement. The saving rate is almost as important as what you are allocating your funds in to.
Investors should play to their strengths. Witcombe says that "simplicity is best." Only invest in what you understand: "Build a portfolio of low-cost funds aligned to the risk that you want to - and need to - take."
It is important to understand that pensions are just one part of financial planning. Witcombe concludes that "working out how much to put into pensions, whether to pay down mortgages, invest in Isas, invest for your children - are all part of wider-financial planning."
Successful Sipp investors must have a talent for stock or fund picking. But they also need a knack for financial planning and cost saving if they are going to retire with anything more than a pittance in the pot.