SIPP stands for self-invested personal pension. It’s a pension investment account with tax benefits that you manage yourself to help fund your retirement. You put in the money, which is then topped up by the government, and you decide how to invest it. Our SIPP is called the Vanguard Personal Pension.
Over the course of this article, we run through everything you might want to know about SIPPs: from when having one might be appropriate and when not, to the various tax benefits and even what might happen to the assets held in a SIPP when a SIPP holder dies.
Why you might want a SIPP
It depends on your individual circumstances. Most employees these days have a workplace pension. By law, this means at least 8% of your salary goes into one, with 5% drawn directly from your pockets and another 3% paid by your employers. But some schemes are more generous with employers willing to match some of the additional contributions that they may make. If that covers you, it makes most sense to fully use any auto enrolment and matching first before considering a SIPP. After all, you don’t want to miss out on those extra employer contributions.
But what if you’re self-employed or work as a contractor and don’t have access to a workplace scheme? What if you change jobs frequently, or expect to, and as a result need a flexible and portable type of account in which to consolidate your different pension savings?
And what if you want to top up the income that your workplace pension will provide and want to do so through a flexible type of pension like a SIPP?
These are some of the types of questions that might lead you to take out a SIPP. It might also cause you to consider consolidating all or some of your retirement finances in a SIPP (More on this in our last question).
What are the tax benefits of a SIPP?
As with other personal pensions, any money paid into your SIPP from your net earnings is automatically topped up by the government1 with the basic-rate tax (20%) that was originally paid on the gross amount. So, for every £80 SIPP contribution, the government adds another £20. And if you’re a higher rate (40%) or additional rate (45%) taxpayer, you can claim back even more via your annual tax return. In this way, it’s theoretically possible to pay as little as £55 to achieve £100 of pension savings2.
In addition, SIPP investments are not subject to income tax or capital gains tax. Dividends received or interest earned within a SIPP is not subject to tax, and neither are the profits you might make.
Where your SIPP tax benefits are capped
If you’re a UK resident for tax purposes you can usually contribute 100% of your relevant UK earnings each year – or £3,600 if this is greater – into your pensions and receive tax relief on these contributions, up to a maximum annual gross allowance of £40,000 for most people.
You can also claim back some of the tax paid in previous years – which has potentially lucrative ramifications for some people. More on this in the next question.
Please note, though, that the annual allowance on pension contributions can be tapered for people earning more than £240,0003. It depends on the level of your pension contributions, among other things. For more information on this, speak to an accredited tax adviser.
There is also a lifetime allowance limit of £1,073,0004. This applies to all your personal and workplace pensions but excludes your state pension. You can save more in your pension(s) than this amount without having to pay any tax. However, when the time comes to draw down your money, you would be subject to a tax charge on any withdrawals over this amount5.
How you can carry forward unused allowances
Unlike your annual ISA allowance, your annual pension tax allowance is not strictly of the ‘use it or lose it’ variety. There is a grace period of three years. This means that unused pension tax allowances from the previous three tax years can be carried forward if you’ve been a member of a pension during this period.
The difference that could potentially make to your pension pot if you’re self-employed, or have volatile earnings, is considerable if you happen to enjoy a particularly profitable year, as it would mean you could invest up to £160,000 of your gross earnings into your pension.
Reaping your SIPP benefits
And once you have done all the hard work and are ready to retire, you can take full advantage of pension freedoms to draw down your pension assets in a manner of your own choosing, whether through a lump sum (up to 25% tax-free) or as income or as a combination of the two.
As with other personal pensions, you can normally access the money from the age of 55. Over and above the first 25%, your income will be taxed at your marginal rate.
What about inheritance tax?
Another, perhaps lesser -known tax benefit of a SIPP is that it can help with inheritance tax planning. This is because anything left in your SIPP when you die typically falls outside of your estate for inheritance tax purposes.
Remember, though: your personal pension isn’t covered by your will, so the onus is on you to tell your pension provider who the beneficiaries of your SIPP will be6.
So what happens exactly to my SIPP when I die?
It depends when you die. If you die before your 75th birthday, then your designated beneficiaries will inherit your SIPP holdings tax-free. As long as you haven’t breached your lifetime allowance, they can take this tax-free inheritance as a lump sum or as income at a time of their choosing7.
If you die after you’re 75, then your nominated beneficiaries will be taxed at their marginal rate of income tax as they withdraw funds from the SIPP.
Using a SIPP to order your retirement finances
Jobs for life are rare these days and getting rarer. If anything, people change jobs more frequently. Sometimes they even change careers. So what are you going to do with all those workplace pensions you’ve accumulated along the way (and may have even forgotten)?
One possible solution is to consolidate them all in a SIPP. By doing so, you can keep track of all your retirement finances more easily, as well as cut down on paperwork. You might also save money if you move to a lower-cost provider.
But beware exit fees and make sure you don’t miss out on any safeguarded benefits when looking to transfer funds between pension providers. If in doubt, ask a financial adviser.
1 Usually after a period of six to 11 weeks.
2 As of UK tax year 2021/22.
3 Work out your reduced (tapered) annual allowance.
4 The lifetime allowance is frozen at this level until 6 April 2026.
5 Currently 55% for lump-sum withdrawals and 25% for income withdrawals, or 25% on anything over the lifetime allowance if you haven’t taken any of your pension.
6 With a Vanguard account, you can do this by navigating to your ‘Account settings’ and selecting ‘Manage beneficiaries’.
7 May be subject to age restrictions. We can’t, for example, pay an income to beneficiaries under the age of 18.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
Eligibility to invest in a Vanguard Personal Pension depends on your individual circumstances. Please be aware that pension and tax rules may change in the future and the value of investments can go down as well as up, so you might get back less than you invested. You cannot usually access your pension savings or make any withdrawals until the age of 55.
If you are not sure of the suitability or appropriateness of any investment, product or service you should consult an authorised financial adviser. Please note this may incur a charge.
Any tax reliefs referred to in this article are those available under current legislation, which may change, and their availability and value will depend on your individual circumstances. If you have questions relating to your specific tax situation, please contact your tax adviser.
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This article is designed for use by, and is directed only at, persons resident in the UK.
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Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.
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