Article from UK MSN Money
December 13 2006
How would you like Gordon Brown to send you a cheque for �40 for every �63 you invest in the stock market?
It sounds unlikely, but it’s actually true. That is precisely what happens to top-rate income tax payers who make their investments through a Self Invested Personal Pension (SIPP) scheme. Under SIPP rules, even a basic rate taxpayer would get a tax credit of £282 for every £1,000 of taxed income they contribute.
SIPPs were introduced in 1989 by the Conservative chancellor Nigel Lawson. The idea was to create a DIY pension of your own investment choice, but keep usual pension advantages. You paid no capital gains tax, made contributions from gross income and reclaimed the tax credit on dividends (this latter benefit was abolished for all pensions in July 1997).
Nevertheless, early SIPPs were confined to wealthy and experienced investors. Set-up fees sometimes ran into thousands of pounds and annual charges were often well into the hundreds. Few had the confidence to turn an investment hobby into the keystone of their standard of living in retirement.
In recent years though, a new breed of lower cost execution-only SIPP providers has appeared. These boast lower set-up costs and dealing costs as low as �12.50, compared to �30-40 that would have typically been charged a decade ago.
Official government advice on pensions
The result has been that investors are flocking to them. By some estimates, £16 million a day is flowing into SIPPs, drawn by the huge range of possible investments, the tax advantages and the low fees.
Most SIPPs are administered online, which is the key to the savings made. Most still charge a couple of hundred pounds to set up and an equivalent amount in annual administration charges, but some don’t. Stockbrokers Hargreaves Landsdown and Killik and Co each now have SIPPs with no set-up cost or annual maintenance fee. Killik is even willing to offer investment advice.
The fund providers have clambered on the bandwagon too, offering low-cost SIPPs with a very wide choice of funds, but sometimes adding extra fees if the fund chosen is not from its own stable.
If you do decide to pay an annual fee, look hard before agreeing to a percentage of the fund rather than a flat fee. A 0.5% fee may sound cheap when you start, but on a fund that has grown to �300,000 in 25 years (this is a fairly typical pension fund value needed to support an annual annuity income of �14,500 at current rates) it will cost �1,500 a year, more than any of the flat rate fees in the market. Look also at the rates of interest paid on cash balances, these vary quite a lot.
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Anyone under 75 can set up a SIPP so long as they are not already an active member of a company pension scheme. If you are employed and have yet to join a pension scheme, you can establish a SIPP into which your employer contributes, just like a personal pension. There are no longer any limits to how much of your income you can contribute by age, except the blanket annual limits of £215,000 (2006/7) and a lifetime limit of £1.5 million (2006/7).
Up to £3,600 a year can be contributed without evidence of earnings. You can also make contributions of this level on behalf of a non-earning spouse. As all SIPP contributions are made net of basic rate tax, that means you actually just send off a cheque for £2,808 to your SIPP provider, and the taxman coughs up the rest to bring it up to £3,600. These credits are paid within a couple of months of your contribution being received. Higher-rate credits are recovered through your tax return.
The answer is almost anything, with the one big exception of directly-owned residential property:
Though the list of permitted investments is huge, you should be aware that most SIPP providers do not allow anything like the full range of investments. Low-cost SIPPs in particular are unlikely to give you much more than shares and unit trusts.
In the end, the only limitation on individuals is your confidence to take charge of your future. It doesn't have to be onerous, though. If you're investing for retirement more than a decade away, stuffing your SIPP with a combination of low-cost stock market tracking funds, a handful of high dividend bank shares, and a good amount in cash or government bonds is a no-brainer portfolio for a relaxed retirement.