How to take control of your pension

If you’re looking for a more flexible pension, take a look at Sipps, says John Greenwood

Sipps (self-invested personal pensions) has been a buzzword in the world of pensions for over two years now, and their meteoric rise shows no signs of abating. More than a quarter of a million people have taken out Sipps since new rules, introduced in April 2006, ushered in an era of unprecedented flexibility in pension saving.

Those new regulations meant that for the first time, millions of people in company pension schemes could set up their own personal pensions too. Restrictions on how much you can pay into your pension each year were also swept aside, replaced with a new cap equal to £235,000 or an amount equal to your annual earnings, whichever is the lower. The Government also made it easier to take money and benefits out of pensions.

Yet, despite all the headlines, some experts believe the Sipp story has been over-egged, and argue that in many cases you are better off with traditional pension arrangements. The FSA, the financial services watchdog, is so concerned at the public's seemingly endless appetite for Sipps that it has warned financial advisers they should not recommend the products when cheaper personal pensions would be more suitable.

Miracle pensions product or the next mis-selling scandal?

The reality of Sipps falls somewhere in between. Sipps can offer significant benefits to people wanting a low-cost pension savings vehicle and also allow investments that conventional plans cannot accommodate. But there are several different types of Sipp on the market and not all will be suitable for your circumstances.

Sipps are not going to solve your own personal pension crisis all by themselves – that can only be achieved by making sure you pay a realistic amount into your retirement savings plan. But used properly they can help you reach your target pension pot more quickly than traditional alternatives.

So what is a Sipp?

Sipps are personal pensions where you, or your financial adviser, decide what your pension savings are invested in.

They offer a far wider choice of mutual fund investments than traditional personal pensions, which generally only offer around 20 funds from one provider..

Unlike personal pensions, Sipps can also hold investment trusts, venture capital trusts, stocks and shares, and commercial property. They can also hold exchange-traded funds, options, and traded endowment policies.

At present, Sipps are unable to hold funds built up from contracting out of the state second pension, formerly known as Serps, although a Treasury consultation on the issue is ongoing and it is expected that this will become permissible in October.

There are three distinct types of Sipp on the market, all of which differ in the range of different asset classes they allow you to invest in.

Supermarket Sipps

Supermarket Sipps are the most basic form of Sipp, typically only allowing you to deal in unit trusts and shares, but they can run at a very low cost. For DIY pension investors who believe they can pick the best funds themselves, supermarket Sipps offer an attractive alternative to the balanced managed funds that are usually the default option on company and personal pensions.

More than 80 per cent of us tick the default box when we join our company schemes, which means that millions of British workers are suffering sub-standard investment performance in dismal life office funds. The average life office balanced managed fund has returned just 60.8 per cent in the last five years of rising markets, compared to a return of 90 per cent even for the average UK equity tracker fund. Star fund managers have performed even better.

While transferring out of a final salary scheme is almost never a good idea, switching your defined contribution pension into a supermarket Sipp is easy. But you should only go down this route if you think you have sufficient understanding of investment markets to manage your fund choices. Putting your eggs in one basket, buying at the top of the market and selling at the bottom are just some of the classic mistakes that can turn your Sipp experiment into a disaster. However, many Sipp providers will give you regular investment updates, fund manager recommendations and online guides to help you construct a sensible portfolio.

Hargreaves Lansdown's Vantage Sipp and similar products from Alliance Trust and Killik & Co allow you to set up and run a Sipp for free, apart from the fund charges. This could save you roughly an extra 0.5 per cent in charges, which can have a considerable effect on your returns over the long term.

"Supermarket Sipps can offer very good value. For example, the HSBC FTSE All Share tracker costs just 0.25 per cent a year, including pension wrapper charges through Vantage, compared to a charge of 1 per cent through HSBC's own stakeholder pension," says Tom McPhail, head of pensions policy at Hargreaves Lansdown.

For some popular funds life insurers are able to negotiate better annual management charges than supermarket Sipps, but in the majority of cases they are more expensive.

If you think you are likely to hold individual shares in your pension portfolio, make sure your Sipp provider allows it as not all do and dealing charges vary; most charge between £10 and £30. Some also charge one-off fees for transferring pension assets from other providers or switching funds, so make sure you check the small print.

Life office Sipps

Life office Sipps are offered by several of the traditional pension companies. They offer similar services to supermarket Sipps, although the one offered by Standard Life, the biggest player in the sector, allows commercial property investment too for an extra charge.

Life office Sipps are generally only available through Independent Financial Advisers (IFAs) and therefore will end up costing you more either through commission or advisers' fees, but you will benefit from expert investment and tax advice.

Last year the FSA warned IFAs against recommending Sipps where personal pensions were more suitable. It was concerned that the Sipp bandwagon was driving savers happy with the handful of funds available through personal pensions, into self-invested products with higher charges. If your financial adviser recommends putting you into a life office Sipp, ensure that it is because you expect to be using its extra flexibility.

"Far too many people have been put into life office Sipps by IFAs when they would have been better off sticking with their original stakeholder pension plan," says Robert Reid, director of Syndaxi Financial Planning.

Full Sipps

Full Sipps are more expensive than the other types of Sipp, and are for people with larger funds who are using their pensions to set up complex financial arrangements. They are offered by smaller specialist firms such as James Hay, Pointon York Sipp Solutions, Suffolk Life and AJ Bell, as well as Standard Life.

One benefit of full Sipps is their ability to allow people who run small businesses to invest their pensions in the commercial premises they occupy. This can be done either on an individual basis or partners or directors can use their Sipps together to purchase the property. Borrowing of up to 50 per cent of the assets held in the Sipp is allowable, and rental income is paid gross into the Sipp.

The Government had planned to allow residential property in Sipps, but this was withdrawn after a public outcry over the effect it could have on property prices. While the idea was criticised by many in the industry, it certainly helped raise the profile of Sipps. Although Sipps may not be ideal for everyone, they can certainly help canny investors build up pension funds more quickly than they could otherwise.

What to watch out for when transferring pension benefits into a Sipp

Switching benefits out of a final salary scheme and into a Sipp is almost always a bad idea. This should only be done after receiving personal independent financial advice.

Some defined contribution occupational pension schemes offer tax-free cash entitlements higher than the standard 25 per cent you are allowed with a Sipp. Ask the trustees before switching out.

Old-style retirement annuity contracts often offer you guaranteed annuity rates that you would not be able to get on the open market. By moving to a Sipp you would lose access to this valuable benefit.

Some company schemes may have negotiated lower charges than you can get through a Sipp, and may have access to external funds that are better than your default option.

Exit penalties on some with-profit pension funds may make it not worth your while switching out. However, paying new contributions into weak with-profit funds does not make sense and these can be diverted into a Sipp. It may also be worth sticking with with-profit funds where there is the chance of a windfall payment.

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