David Seaton, joint managing director at Rowanmoor Pensions, describes the parameters of the SIPP rules

Since the launch of self-invested personal pensions (SIPPs) by the then chancellor Nigel Lawson in his 1989 Budget, there have been numerous alterations when it comes to the rules and regulations. For example, many will recall the change made within the Finance Act 2004 that saw a new tax regime introduced with effect from 6 April 2006 (‘A-Day’). In 2007, another major change, the requirement for the operator of a SIPP to be regulated by the Financial Services Authority (FSA), was introduced.

Most SIPPs are established under a trust, with the trustee company controlled by the operator. Each member has a separate plan within the trust and has the right to direct the trustee to invest and disinvest their fund according to their wishes. This flexibility gives the member control over how the pension fund is managed and is why SIPPs have become one of the most popular forms of pensions.

Is it in or out?
In redesigning the pension rules, the government did not define acceptable and unacceptable investments; instead it defined certain investments as being ‘unauthorised payments’ and made them subject to tax charges. For all intents and purposes, any investment that gives rise to an unauthorised payment is therefore effectively unacceptable.
The list of those investments that aren’t permitted into a SIPP is also quite short and consists of loans to members or people or companies connected to them, tangible moveable property (with the exception of tradable gold) and residential property.

This leaves a huge list of possibilities, including investment funds, quoted and unquoted equities, pooled funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). However, many SIPP operators have gone much further in what they will allow into their product plans. Indeed, the main differentiator between SIPP providers is what they will and will not accept within their SIPP.

At the simple end of the market, the list of acceptable investments is limited to unit trusts and other pooled investments. A little further up the scale, the operator will allow investments quoted on a world stock market. At this level, some operators will even restrict where cash may be held, by requesting that all cash be held in their own nominated account, whereby they will receive commission from the bank.

Some SIPP operators will permit investment in commercial property, with or without a mortgage, which is restricted by the Finance Act 2004 to 50 per cent of the net assets of the scheme at the time the mortgage is executed. Few, however, will permit offshore property.

To be able to invest in the more exciting offshore property ideas in the market a client must seek out a specialist SIPP operator. Such opportunities include hotel rooms in the Caribbean or Cape Verde (which, provided they are part of a commercial hotel, are not regarded as residential property), a vineyard rented back to a connected company and even the mooring for a boat in a marina that is rented back to the member. However, certain offshore jurisdictions like France and Spain do not recognise the legal entity of a trust and buying in these countries is often very difficult, if not impossible. Property taxes are invariably different, with annual taxation being payable on the property. Similarly, there can be huge issues in respect to inheritance tax rules on the death of the member, making buying property in these regions unviable. 

Many SIPP operators will also be hesitant in accepting other more ‘exciting’ assets such as unquoted equities, which can be troublesome, nor will they accept intangible assets such as patents and copyrights. Members contemplating investing part of their SIPP in any of these more esoteric assets must understand that by their nature they are difficult to value, therefore any information with regard to benefits from the operator cannot be prepared until proper valuations have been obtained. This can be time consuming and costly.

Every penny counts
Costs between operators vary considerably, as do the permitted assets available. Be aware of the free SIPP, there is no such thing. As a rule, if there are no set-up or ongoing administration fees applied, the costs are recouped elsewhere. For example, there may be no initial charges, but all investments must be made via a nominated bank account, which can receive perhaps 0.5 per cent commission, or made and held through the operator’s nominated investment platform, where initial commissions and up to 0.75 per cent trail commission can be taken annually. A £500,000 SIPP could therefore earn them £3,750 – hardly free. 

Investing in the more esoteric investments will naturally increase the costs. Property needs to be managed and there will be solicitors’ fees to pay as well. At the top end of the scale, with a number of complex assets, it could cost around £1,500 a year. However, for a £500,000 SIPP, this only represents a charge of 0.3 per cent. When compared with the more expensive bespoke SIPPs, which allow investment in most assets and cost around £300 to set up and around £500 a year in management fees, the ‘free’ SIPPs can seem very expensive and suddenly not quite so attractive. 

Nevertheless, the low-cost SIPP should not be written off. Using a simple, low-cost SIPP to initially build funds to a value of perhaps £100,000, before transferring to a bespoke SIPP, can be an option.

Contributions are acceptable either from the member’s employer or from the member themselves. Employer contributions are paid gross and are usually accepted as a business expense for tax purposes. The member contributes net of basic rate tax. The operator collects the basic rate tax back from HM Revenue and Customs (HMRC) and the member can claim higher rate tax relief through their annual tax return if applicable. A member may make unlimited contributions but will only receive tax relief on 100 per cent of his net relevant earnings up to the annual allowance, which is currently £245,000 or, if the member has no earnings, £3,600. For those who are described by the government as high earners, i.e. paid tax on total income of £150,000 or more in this or one of the previous two tax years, the government is restricting the annual allowance next year as part of complicated anti-forestalling measures.

Providing an income
Benefits may be taken from age 55 (50 until 5 April 2010), and provided the lifetime allowance, currently £1.75 million (from all registered pension arrangements), has not been exceeded, 25 per cent of the fund may be taken tax free as a pension commencement lump sum. The remainder is then used to provide an income subject to income tax.

An income may be taken from the fund by way of purchasing an annuity from a life assurance company or through income drawdown, now known as unsecured pension, until the age of 75. At 75, drawdown may continue under an alternatively secured pension (ASP) or, within some SIPPs, a scheme pension. Most investors with funds in excess of £200,000 opt for drawdown in the early years, considering annuity purchase after age 70. Funds of less than £200,000 are not usually suitable for drawdown since the fees can make such a plan less viable.

If death occurs before taking any benefits, the entire fund, up to the lifetime allowance, is available for beneficiaries free from any tax. If benefits have commenced (either the pension commencement lump sum or through income drawdown) then on the death of the member, before age 75, a dependant can receive a pension, or they and any other beneficiary can receive the remaining fund less a tax charge of 35 per cent. Death post age 75 provides for a dependant’s pension, but no lump sum can be taken and any fund remaining on the death of the dependant is hit with a tax charge of 82 per cent tax.

For any taxpayer, the benefits of making pension contributions are significant. For the growing number of people who make hefty contributions, and will have a pension fund in six figures, SIPPs offer a unique savings vehicle where the member can exert control over where their money is invested. Even if the member will always rely on an IFA to advise them on their investment strategy, the SIPP is a serious contender.