Friday, 18 March 2011

DIY Income SiPP (UK)

sipp
Source
The DIY Income Investor approach involves shielding savings and investments from the taxman. In the UK, there are two main ways to do this:
  • an Individual Savings account (ISA)
  • a Self-invested Personal Pension (SiPP)
They are both quite similar to operate for the DIY Investor but they have different implications for tax and access to your money.

This post gives some basic information about SiPPs - what they are, how they work and how to find a suitable one.

What is an SiPP?
 
A SiPP – a Self-Invested Personal Pension - is a pension tax 'wrapper', that means you don't pay income tax on contributions (up to certain limits - even if you are not working). Within a SiPP, you can manage your own investments - in this case, as a DIY Income Investor.

Although it was originally created for more wealthy investors, the new no-frills online versions - eSiPPs (electronic SiPPs) -  have brought personal pensions within the reach of everyone. A typical  'low-cost' electronic SiPP is simple and inexpensive to open and operate; they are (according to This is Money) probably the 'future' of pension saving.

When you come to retire (the earliest age is currently 55) you can use your SiPP pension fund to buy an annuity or you can 'draw down' income from your fund, leaving most of it to grow. In most cases I am assuming that you will take an annuity - which will give you guaranteed income for the rest of your life (and possibly that of your spouse, depending on the type of annuity).

Who would benefit from a SiPP?
 
For those in employment, you will receive a refund on any income tax paid on contributions to your SiPP (up to a limit).  However, you will potentially have to pay income tax on any annuity or income you take from the SiPP in the future - although then you are likely to be liable only for basic rate income tax.

For higher rate taxpayers on a rate of 40% or even 50%, this is obviously very beneficial - as the taxman is effectively giving you 20% to 30% of your contribution 'for free' (40% or 50% going into the SiPP, less 20% coming out)!
It's a less clear-cut issue if you only pay basic-rate tax, as your money is tied up for so long.

A company pension may hold greater benefits, such as contributions from your employer - and many allow you to add to the minimum contributions.

However, you can also open a SiPP for your partner and children - and get a tax refund - even if they don't work or pay income tax. I call this an 'instant 25% return'.

A Do-It-Yourself eSiPP

Of course, you'll have to do your homework, make your own investment decisions and regularly monitor your investments.

Still - The DIY Income Investor blog will try its best to help you find the information you need!

How to find a SiPP

SiPPs come in very different shapes and sizes - from low-cost to hybrid to bespoke - and with confusing charging structures. What you need to look for - as a DIY Income Investor - is a low-cost eSiPP with the following key features:

  • A low set-up fee: It may even be free
  • A small annual management fee:  Some are free but some will charge a small percentage or flat fee every year (that will eat away at your returns). 
  • Cheap dealing charges on shares and other investments: You won't actually be doing a lot of dealing, so dealing charges are less crucial to your decision
  • Reasonable transfer fees (if you already have a Personal Pension): These are charges applied for moving money, funds or shares into a SiPP from another pensions provider. Also, check if there any exit fees on moving to another pension provider
  • Interest rate on cash: Interest rates on cash left in a SiPP can vary from nothing much to a reasonable rate of return. Then again, you won't have much cash lying around (as you will want to keep it working harder)  
  • Reasonable other charges: These might include the costs of buying an annuity, costs for paying out on death, etc. However, these are one-off charges and are therefore will be less important in the overall scheme of things

As far as the cheap providers go, the market leaders are Hargreaves Lansdown, Alliance Trust and Sippdeal (from provider, AJ Bell). From personal experience, I can recommend Sippdeal / iDealing.

Update: information on available SIPPs and their costs can be found at Investment Sense.

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.