For those thinking of leaving the business world, a well-equipped pension fund is essential. The question is, can you fortify your retirement pot while still building your wealth as a company employee?
While many of us are likely to be well acquainted with traditional pensions, you may not be as familiar with the Self-Invested Personal Pension, or SIPP for short. Unlike run-of-the-mill pensions, SIPPs allow for greater flexibility and control when it comes to building your funds for retirement, but is it worth opening one or consolidating your existing pensions into a SIPP?
Whether a SIPP is right for you is one thing, but there’s plenty of evidence that suggests the investment strategy is growing steadily in popularity.
The introduction of pension freedoms in 2015 has seen a more widely democratised pensions market. This has paved the way for 1.7 million people to hold SIPPs by 2023, representing some £205 billion in assets.
But what actually are SIPPs and are they right for you? Let’s take a deeper look at the pros and cons of Self-Invested Personal Pensions:
What are SIPPs?
In a nutshell, a SIPP, or Self-Invested Personal Pension, is a tax-efficient personal pension that provides more flexibility and control over the funds you’re raising in preparation for your retirement.
You pay your own money into your SIPP, which will then be invested in a broad range of investments such as shares, bonds, and property.
What makes SIPPs so appealing to investors? This form of pension fund allows individuals to build their retirement pot alongside some significant tax benefits. For instance, you don’t pay capital gains or income tax on your investments as they grow, and you can also access an instant government tax relief top-up of 25% alongside your personal fund contributions.
In practice, this means that you can pay £2,000 to your SIPP, and the government will add another £500 on top, bringing your total contribution up to £2,500.
Crucially, the extra control that a SIPP allows savers means that it’s possible to adjust how much you pay and on what basis. This quality makes Self-Invested Personal Pensions an appealing option for self-employed individuals looking to make personal contributions as well as those seeking to build on their workplace pension ahead of retirement.
The Pros of Opening a SIPP
Self-Invested Personal Pensions offer a range of benefits surrounding taxation, higher levels of control, and investment flexibility. They include:
Tax Advantages
There are plenty of tax advantages associated with opening a SIPP. As we’ve already touched on, individuals are entitled to an exemption from capital gains tax, with the government contributing a relief top-up of 25% on contributions made to the pot.
Additionally, at the age of 55, you’re entitled to withdraw up to 25% of your SIPP pension pot as a tax-free lump sum. However, it’s worth noting that this threshold will rise to 57 years of age from 2028.
These benefits also apply to personal business taxes and inheritance, where beneficiaries can inherit your SIPP tax-free should you pass away before the age of 75. After 75, beneficiaries will be required to pay marginal income tax on withdrawals.
Greater Flexibility
Another key advantage is that SIPPs allow you to tailor your pension portfolio to your personal financial goals and risk tolerance levels.
This means that you’re free to build a diversified portfolio that’s comprised of investments like stocks, bonds, mutual funds, exchange-traded funds (ETFs), investment trusts, and commercial property.
Embracing this added flexibility empowers individuals to save for retirement on their terms. However, if you decide to curate your investments without seeking the help of an adviser, there’s a greater chance that your SIPP could be more vulnerable to market fluctuations and potential losses.
Full Control
Your SIPP enables you to shape your pension investments according to your financial goals. While traditional pensions are limited in terms of your selection of funds, you’re free to choose a Self-Invested provider that offers the platforms and tools you’ll need to take full control over your investment decisions.
With the right access to market data, real-time investment news, research reports, and learning portals, you’re free to build a fully customised SIPP to suit your needs.
Potential for More Returns
The flexible nature of SIPPs means that investors have more chance of unlocking higher returns through direct investments within their pension fund.
While traditional personal pensions are more likely to be balanced by providers, SIPPs mean you’re free to choose riskier investments to grow your nest egg faster.
However, it’s important to note that adopting more risk could easily lead to greater losses and weaker returns.
The Cons of Opening a SIPP
Despite their clear advantages, SIPPs come with some drawbacks that you should consider before you begin saving. These include:
Added Charges
Although SIPPs are more flexible than traditional pensions, this freedom does generally come at a cost. There are many different potential fees that individuals using SIPPs should be aware of.
For instance, SIPP providers can charge annual administration and management fees that can eat into your investments. Furthermore, the funds or investments you choose for your SIPP can have their own added charges levied by fund managers and platforms.
These actively managed funds can lead to higher annual charges of 1% or more, although passive funds are considerably lower should you decide to hold your chosen shares.
Time-Consuming
Another drawback of the added flexibility of SIPPs is that they can become too complex for many individuals.
Building your own SIPP can put you in touch with thousands of stocks and assets that will require sufficient research and time commitments to ensure you gain the best profitability from your options.
Results Aren’t Guaranteed
While SIPPs can provide higher levels of returns for investors, there’s a chance that you’ll have nothing to show for your savings when you reach retirement age.
Although stock markets and investment options like government bonds historically appreciate over time, there’s no guarantee that your SIPP will be worth more in the future.
Poor investment decisions or early withdrawals could deplete your funds at a rapid rate which could undermine your retirement pot.
Is a SIPP Right for Me?
In terms of deciding whether a SIPP or a more traditional pension is right for you, a key factor would be to assess how hands-on you would like your pension plan to be.
If you don’t have the time to build a bespoke portfolio to build your retirement nest egg, it may be worth opting for a traditional personal pension.
However, if you’re an experienced investor or are self-employed, setting up a SIPP could be an effective way to gain greater control over the wealth you can build into your retirement.
With a fund created to suit your financial goals and risk appetite, a Self-Invested Personal Pension could be just what you need to build a nest egg on your terms.
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