Pre-Budget Update December 5th
In his pre-budget speech on December 5th the Chancellor Gordon Brown announced that residential property investments within a SIPP would not qualify for immediate tax relief.
This move was described by a Treasury spokeswoman as "a proportionate response to an unintended consequence of simplification."
The new arrangements as outlined in the pre-budget speech indicate that although money put into a SIPP would attract tax relief, if that cash was then used to purchase residential property then it would attract up to 40% tax.
However, once the property had been purchased and was inside the SIPP it would still, as before escape both capital gains tax and income tax on any rent paid. This new policy will apply to other assets such as works of art, wine, classic cars etc.
Overall this change will make investing in residential property or these other "fixed tangible assets" less attractive but may still appear to some long term investors.
For many investors a SIPP (Self Invested Person Pension) provides a very useful wrapper in which to shelter investments from tax. SIPPs have been around for many years and in many respects are similar to personal pensions or stakeholder pensions. However, they offer a much broader range of potential investments and this is set to expand greatly in April 2006 - so-called A-Day.
However, we should not lose sight of the fact that a SIPP, like any other pension vehicle, is primarily a way to save for retirement. With costs of setting up and administering SIPPS falling they have become accessible and attractive to a much wider range of potential investors. And in April 2006 they will become even more attractive.
One of the main attractions of a SIPP is that it enables you to take direct control of your pension and to make all your investment decisions yourself. But that carries with it certain responsibilities so the first question to ask should be - do I want to become actively involved in my retirement investment planning? Have I got the time and the aptitude to make a good job of it? If the answer to these questions is a categorical no - then maybe a SIPP isn't for you.
Like any other forms of pension investment, SIPPs benefit from certain tax relief advantage. The government effectively provides an additional 28p for every pound that you contribute, and higher rate tax payers can get their tax bill reduced by a further 23p on top of this! And so long as you are under 75 virtually everyone will be entitled to this benefit - but a quick caveat - these figures are correct at the time of writing but are subject to change - so check first.
One of the key advantages of a SIPP over other forms of retirement saving is the much wider range of assets that are eligible. For active equity investors this includes a wide range of stocks and shares including Main Market and AIM. And you can make your own investment decisions and buy and sell when you want.
In a normal Personal Pension you can only include Insurance company managed funds but with a SIPP you can currently also include Unit Trusts, Investment Trusts, OEICS, individual equities (both UK and overseas as well as gilts, bonds and other fixed interest securities such as PIBS, futures and options, cash deposits and commercial property. However, from April 2006 (A-day) you can also include shares in private companies and OFEX listed companies, residential property and assets such as gold.
Further information on many of these assets is included in our other fact sheets.
It is perhaps the planned inclusion of residential property that has most excited the imagination of UK investors and the press alike. But this is by no means a simple decision to make and caution should be exercised before rushing out and investing in property in a SIPP. For instance, you won't be able to just transfer any existing property you own into a SIPP. You must effectively sell it to your pension fund. However it is possible to borrow up to 50% of the value of any property to buy for your SIPP. If the value of your SIPP was £200,000, you could borrow an additional £100,000 to purchase a property for £300,000 - but that is considerably less than you could borrow using a traditional buy-to-let mortgage if you were going to own the property direct, where you might be able to obtain borrowing of up 85% LTV. You should definitely obtain professional advice before considering investing in property via a SIPP.
Like any form of pension investment the earlier you start investing in a SIPP the better. The amount of money you have available in your SIPP will determine the sort of assets that you should consider investing in. Property investment should only really be sensible for investors who have built up a substantial fund and even then you should aim for a balanced portfolio including equities, and fixed interest securities. The expected time before planned retirement will also have a big impact on the suitability of different asset classes. The conventional wisdom being that the nearer you are to retirement to more you should consider protecting your capital by switching to fixed interest securities.
Most Personal Pension plans tie you to the funds of that particular fund management group and a limited number of externally managed funds, whereas with a SIPP even if you elect to keep most of your funds in collective investments you will have much more choice, and diversification should be a vital part of anyone's investment strategy.
There are a few disadvantages with SIPPs. The can be slightly expensive especially if the value of your funds is fairly low and they do require a fair amount of effort and involvement on your behalf. An almost unlimited choice of investments could be viewed as both good news and bad news - fantastic opportunities for diversification and flexibility but this level of choice can be bewildering!
Asset allocation within a pension fund is a subject in its own right but the conventional wisdom is that diversification is extremely important and any portfolio should always contain a range of asset types and exposure to different markets. The "blend" of these assets should be adjusted the closer you get to retirement. Someone aged in their twenties or early thirties would be best advised to invest in assets that have the potential for strong capital growth such as equities or property, but the nearer one gets to retirement the greater the proportion of funds that should be transferred into fixed interest of cash based securities to protect the capital that has been built up.
When retirement age is reached then more decisions have to be made. At the time of writing up to 25% of the value of the fund can be taken as a tax free lump sum. The remainder must be used to secure an income and the options include purchasing an annuity, an income drawdown or phased retirement.
There are two main types of annuity, a conventional one is fixed and secure whereas with an investment linked annuity the income will fluctuate. Under the current legislation you must purchase an annuity before you get to 75.
Income drawdown, as the name suggests, allows you to take out of your fund a certain amount of income each year but still leave the remainder in the fund and benefit from investment growth. The phased retirement approach allows the total fund to be divided into a number of segments with each one used to generate a series of annuities and tax free lump sum payments. There may be tax advantages with this approach - again consult an expert before making any decisions.
There are also Inheritance Tax benefits of a SIPP. The full value of assets within a SIPP at the time of death would normally pass to your beneficiaries free of inheritance tax unlike assets held directly.
So although SIPPs probably aren't suitable for everyone they do offer significant benefits over other forms of retirement planning and should be carefully considered. With A-Day fast approaching (April 2006) they will become even more attractive especially for investors in residential property but do your research and take professional advice before proceeding.