A SIPP is an acronym for Self Invested Personal Pension
A SIPP is not necessarily subject to UK taxes during draw-down and is free from capital gains tax, it is also outside your estate for inheritance tax purposes. Depending on where you are living at the time of taking draw-down you may be able to take advantages of double taxation agreements between that country and the UK which may mean you will be subject to lower taxes.
SIPPs offer far more flexibility with regard to pension planning than Final Salary schemes. Although QROPS were very popular with expatriates living in China they were not necessarily popular with the UK Government and on March 8th 2017 the UK Chancellor announced a withholding tax of 25% on transfers into QROPS where the member lives outside the EEA or where the member lives in a country outside the EEA where no approved QROPS is domiciled. The changes came into force the following day and were quite a surprise to everybody including senior people in the personal financial industry. Please see this page for more detail.
It is unknown what will happen regarding the rights to transfer a pension after the UK eventually leaves the EU. An International SIPP can be moved into a QROPS at a later date, for instance when a member retires in a European country for zero fees if a suitable provider is chosen – contact me for guidance.
Key Features of a SIPP
- Income Drawdown – there is no requirement to purchase an annuity even at the age of 75. Income may be drawn down as the client wishes.
- Taxation on Pension Income – income is subject to where the member is living or deemed to be resident.
- Retirement Age – this is normally 55, but there is flexibility in the case of ill health or at trustees’ discretion. Special provision can also be made for example with sports professionals such as footballers and boxers. Some SIPP schemes may not allow early retirement or conversely insist that benefits are taken before a certain age.
- Death Benefits – The client has complete control of their money and therefore complete control over choice of beneficiaries.
- Other Taxes – a SIPP is not subject to IHT upon the policy holder’s death and the funds are also not subject to capital gains tax or the European Savings Directive. Not only does a SIPP sit within a tax wrapper, there are no lifetime allowances that can be applied (LTA tax). All these benefits make the product very popular for UK expatriates, particularly as UK- regulated investments are allowed.
- Other Assets – a client who holds other assets in the form of investments, directly or via collective funds, like mutual funds or unit trusts, can use their SIPP to purchase them (or wrap them), allowing the funds to grow in a tax-efficient manner and at the same time moving the assets out of their estate from the IHT viewpoint. The funds that are available are typically offshore versions of major funds and typically grow much faster than domestic funds as they also benefit from lower costs and no tax at source taken from their dividends.
- Currency Choice – The client has a choice to receive their income in any one of several major globally used currencies – shielding the potential downside devaluation (as we saw with GBP pound after Brexit in summer 2016 – a comparative 20% drop in overseas spending power)
This is quite a significant advantage and therefore demands further explanation. Firstly , consider having a Defined Benefit ((DB) Final Salary) scheme and at the point of commencing draw down and having no choice but to take out an annuity. Typically, should the client pass away then the spouse (or civil or same sex married partner) may receive 50% of the income. When they die, that is ‘it’ and if both were to die relatively young the Life Assurance company that issued the annuity ‘wins’! Most annuities do not cater or offer any income for children over the age of 18 years or sometimes 23 years if in full-time education. They also may prohibit or greatly reduce any income paid to spouses who are more than 10 years younger.
Conversely, the freedom that a SIPP provides means that the client has complete freedom on when and how to receive income. For instance a portion of the ‘pot’ may be used to purchase an annuity with appropriate benefits. The ideal strategy is to create a pot that can remain invested generating a yield that is sufficient for income purposes. On death, the pot remains intact and can be passed to any of your chosen beneficiaries. These can be anyone and not necessarily restricted to spouses.
The current Pensions Schemes’s actuaries calculate a Cash Equivalent Transfer Value (CETV) These may be approximately 20 times the predicted pensionable amount of a final salary scheme. As mentioned on other pages on this web site, these amounts are currently at historical highs due to the actuaries having to factor in the historical lows in bond prices brought on by low interest rates and the uncertainty caused by the recent Brexit discussions and the future of the UK’s economy.
As part of the process a client should obtain a report which includes a Transfer Value Analysis System (TVAS) . This must be from an FCA regulated advisory firm in the UK. This calculates the annual investment return, known as the critical yield required of a new pension arrangement to match the benefits available from a defined benefit scheme at the date of retirement. Therefore if the transfer value grows by the critical yield each year until retirement it will provide a fund that matches the capitalised value of the defined benefit scheme.
The TVAS makes a number of assumptions about;
- annuity rates
- national averages
- revaluation rates
- investment returns
The critical yield therefore is only going to be accurate if all the assumptions become reality. We are not privy to any of their assumptions, the only thing anyone knows for sure is what has happened in the past!
So although the critical yield will help to put into context that transferring from a DB pension to a SIPP arrangement moves the investment risk from the employer to the member and the target required to equal or better the benefits thereof, however –
Critical yield should only be treated as a guide not the nub of the matter.
The decision needs to be the best one for the individual and can be quite complex – this is why it is best to work with an experienced Financial Adviser in these matters (you know who to call!)
For some basic balanced information on the past performance to balance the critical yield calculation let’s look at the following;
The average performance of the S & P 500 over the last 80 years has been 9.6% annually. Figures are from here; market watch .com
After product fees and annual management charges in funds and a bit of caution let’s say net 6%.
So if the critical yield calculation delivered a result of 6% – what should a client do?
The advantages of QROPS mentioned above need to be evaluated.
The FCA report may suggest against transfer – but they are towing a government line – this is changing – please see the Financial Times article from Dec 31st 2016 if you haven’t already on the DB page – click here
The other advantage of SIPPs are as follows; – and you’ll be pleased you read this far – well done!
Let’s say the client has a CETV of £150,000, is age 40 and seeks to retire at 60. Funds are invested in a selected group of well managed multi-asset mutual funds yielding 6% net.
This would create a pot of £481,070 in 20 years time. (an example of the powerful effect of tax free, compounded interest growth *)
Taking an income of 5% (which is hopefully slightly less than the growth) would mean an annual income of £24,053
The pot remains intact – (unless you want to spend some of it!)
Client has an income for life
Client can pass as much as possible to chosen beneficiaries
Client wins – not the Life Assurance companies!
The usual caveats apply and the value of investments can go up and down etc, but the facts remain that the best investment over time has been equities. The longer the time horizon you have the more opportunity you have to ride out any down market periods.
* If you would like to learn a bit of financial planning wizardry and be able to calculate the future value of a lump sum amount at various interest rates and varying investment horizons – get in touch!