SIPPs are similar to many other types of pension, in that you make contributions to a scheme which are then invested in assets to grow over time. Once you reach 55, you can use this fund to provide you with an income in retirement.
The main features of SIPPs are:
Tax relief on your contributions
If you make contributions to a SIPP, these will be boosted by basic rate tax which the SIPP provider will claim on your behalf. If you are a higher or additional-rate taxpayer, you can claim additional tax relief through your tax return.
So, if you put £80 into a SIPP, the Government will add £20, making £100 in total. If you are a higher-rate taxpayer, you can claim a further £20 tax relief via your tax return. If you are an additional-rate payer, this rises to £25.
You don’t have to be a taxpayer to benefit from tax relief. Almost anyone can put up to £2,880 into a pension each year, and have this increased to £3,600. You can even set up a pension for your children.
Providing you have sufficient earnings, you can contribute up to £40,000 a year and benefit from tax relief, possibly more if you have not used up your annual allowance in the past three years. If you exceed the limits, you will normally be taxed on the excess.
There is also a lifetime allowance of £1,073,100 which applies to all your pensions. If you go above this limit, you could be charged up to 55% tax on the excess.
Today’s SIPPs usually provide you with a wide range of investment options. So you can tailor your portfolio to your needs and your attitude to risk.
You should check if the SIPP offers access to investment companies.
Investments within the SIPP are not subject to income tax or capital gains tax.
Tax-free lump sum
Once you have turned 55 (rising to 57 in 2028), you can take up to 25% of your fund tax free. Any withdrawals after this are taxed as income.
Thanks to tax relief, every £100 you put into a SIPP could cost you only £60, or even less. Since April 2015, you have had complete freedom over how you can take an income from your pension
Income in retirement
At present, when you start to draw a pension, you can either purchase an annuity or go into what is called ‘income drawdown’.
An annuity provides a safe and predictable income, but can be inflexible as, once you have made your choice, you cannot change your mind.
You also cannot pass on the money you use to purchase an annuity to your children when you die. With income drawdown, your pension remains invested and you draw an income off it. If you are uncertain of the implications, or have already drawn some of your pension, you should speak to a financial adviser.
Flexibility in retirement
Since April 2015, you have had much more freedom over how you take an income in retirement. No one is required to purchase an annuity, and the rules limiting how much you can take using income drawdown were scrapped.
Instead, you are allowed to take as much or as little money from your pension as you want at any time provided you are 55 or over. The first 25% remains tax free, and the rest will be taxed as income at your marginal rate of income tax.
You should be very careful to make sure that you have enough money for your retirement, and for some people an annuity may still be the best option.
But if you have plenty to live on, you can choose to leave some of this to hand down to your children. Drawdown of pension income will be taxed at your normal income tax rate. Because this is a complicated area, the Government organised that everyone nearing retirement gets access to free, impartial guidance to help them understand their options. The Pensions Advisory Service is the organisation that provides this guidance. You should make sure you take advantage of this, and possibly speak to an independent financial adviser to help you decide exactly what option is best for you.