Saturday, 25th February 2017

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Tax efficient investing with ISAs and SIPPs

Introduction

Individual Savings Accounts (ISAs) and Self Invested Personal Pensions (SIPPs) offer the flexibility to control your own investments within a tax-advantaged wrapper where invested funds grow free of UK Capital Gains Tax.

Both ISAs and SIPPs allow you to choose from a wide range of investments including UK Equities, International Equities, Gilts, Bonds, Investment Trusts, Unit Trusts and Exchange Traded Funds. In addition, SIPPs also allow investments in cash, and trading in derivatives such as Covered Warrants and Contracts for Difference

What are SIPPs?

SIPPs are one of the most flexible pension products available in the UK, giving you the ability to make their own decisions about where, how and when investments are made.   SIPP investors can build up diversified portfolios through investment in a wide range of allowable asset classes including cash, UK and International Equities, Gilts, Bonds, Exchange Traded Funds, Unit Trusts, Investment Trusts, Warrants, Covered Warrants and even Contracts for Difference.  Commercial Property is also allowable in some SIPPs.

While they are often thought of as suitable for only the most sophisticated investors, SIPPs are flexible enough to meet the needs of almost any pension.  Anyone managing an ISA or share portfolio online for example would probably be equally comfortable with an online SIPP. 

SIPPs offer an ideal shelter for bonuses and other lump sum investments, even if you already have an occupational pension scheme, or can provide a cost effective way to make regular smaller contributions over a longer period.

They also offer the widest choice of retirement options, including a tax-free lump sum of up to 25% of the fund, phased benefits, and the options of annuity purchase or income drawdown (recently renamed “unsecured pension”).Up to questions

Tax advantages of SIPPs

Like all other pensions, SIPPs are a tax efficient way of saving for retirement.  Contributions to pensions automatically receive tax relief at 22%, significantly boosting the amount of money available to invest. 

As an example, if you wished to add £10,000 to a SIPP you would need to make a contribution of just £7,800 and the government will automatically add £2,200 to this sum.  Even non-tax payers are entitled to this tax relief on contributions up to £3,600 gross.

Higher rate tax payers can also claim a further 18% tax relief on the basic rate relief, giving total tax relief of 40%.

In addition, gains on invested funds are tax free and there is no further tax to pay on any income received from dividends or other sources.Up to questions

Increased simplicity and flexibility for SIPPs post A-day

On April 6th 2006, Pensions Simplification A-day ushered in some dramatic changes to the way UK pensions operate with a radical overhaul of pensions rules.  Whereas pensions could previously operate under one of eight different tax regimes, a single set of tax rules now covers all pension plans.

In addition to maintaining the flexibility already enjoyed by SIPPs, the new rules introduced the following changes:

  • Concurrency:  An individual was previously limited to the number of pension schemes that could be joined, particularly if they already had an occupational pension. New concurrency rules mean that even members of an occupational scheme will be able to join additional pension schemes such as a SIPP.
  • Contribution limits:  Complex tiered limits on pensions contributions have been swept away, replaced by a system of annual allowances. These allowances have been set at £215,000 in 2006/7 rising annually to £255,000 in 2010/11. Tax relief is available on personal contributions up to £3,600 or 100% of earnings (whichever is the higher) at the basic rate of tax. Higher rate taxpayers can then claim back further tax relief.
  • Lifetime allowance:  A new lifetime allowance, determined at the date benefits are taken, has been set at £1.5million in 2006/07, rising to £1.8 million in 2010/11. Despite the introduction of the lifetime allowance, the vast majority of people will be able to pay as much as they want into a pension, accumulate a pension fund much more quickly and still benefit from tax relief at their highest personal rate.
  • Retirement options:  Sipps have always offered the widest choice of retirement options, including a tax-free lump sum of up to 25% of the fund, phased benefits, annuity purchase and income drawdown ( to be renamed “unsecured pension”). After A-Day this flexibility was increased further as it is no longer compulsory to buy an annuity by age 75. Instead income withdrawal can continue as an “alternatively secured pension”. Confirmation of the inheritance tax position is still awaited but potentially an individual will also be able to pass on any unused pension funds to their heirs on death.
  • Retirement age:  The minimum age at which benefits can be taken rose from the age of 50 to the age of 55 from 2010.   But of course there is no need to “officially” retire, and phased retirement is likely to become more common as part-time work replaces a traditional retirement. 

Up to questions

Online SIPPs

In addition to the usual benefits associated with a SIPP, an online SIPP offers even greater flexibility and control over your savings for retirement.  With the ability to monitor the performance of your portfolio 24 hours a day 7 days a week, and make changes to the range of investments you hold as often as you like, you can take control of your pension in a way not otherwise possible. 

Online SIPPs are generally provided by execution-only brokers, and are effectively a trading account designed to allow direct investment in the stock market within the tax wrapper of a pension plan.  This means that savings for retirement can easily become an integrated part of a total savings and investment portfolio, rather than an isolated and often ignored plan. 

Although execution-only brokers do not offer investment advice, the better ones do provide a range of free information to help you research your investment decisions before you make them.  In addition to being able to research individual equities – with everything from up-to-the-minute news stories to sophisticated charting tools - it is possible to compare the performance of funds, and even learn about using more sophisticated tools such as covered warrants.

One criticism of SIPPs in the past has been their relatively high cost, making them suitable only for investors with larger pensions, but today’s low cost online providers have changed this.  Online SIPPs are now available with set-up fees under £100 and administration charges from as little as 0.5% per annum – far less than you would expect to pay in fees on a traditional pension.

This means that whatever the size of your pension, and however you would like your contributions to be invested, an online SIPP can be a cost effective option.  More sophisticated investors who want to actively manage a pension can do so – switching in and out of investments for little more than £10 in many cases – and monitor their performance in real time.  At the opposite end of the spectrum, it can also be a cost effective way to simply invest in a fund, or a number of funds for the longer term.

Online SIPPs do have some limitations - notably the restriction on investing in commercial property – but for the majority of people wanting a personal pension, they are an increasingly attractive option.

Choosing an online SIPP doesn’t have to mean giving up paper statements or the flexibility to trade by phone either.  Most providers will send you regular account statements by post and provide telephone services as part of their SIPP service.

Even opening your SIPP is quick and easy with an online provider.  In some cases it is possible to complete your application online, and even where this isn’t an option a paper application can be processed within a few days.

The traditional view that SIPPs are a complex product lacking universal appeal is beginning to change, and increasing numbers of people are recognising that they can offer a flexible and cost effective solution to their pension needs.  As the message about their benefits continues to spread, we can expect to see online SIPPs continuing to build on their successes to date.Up to questions

What are ISAs?

Since their launch in 1999 as a replacement for PEPs and TESSAs, ISAs have become a popular product with investors in the UK. In late 2006 the Chancellor confirmed that the ISA would continue to run indefinitely past 2010, recognising that these accounts have an important part to play in encouraging long term savings and investment.

Although the benefits of an ISA will be greatest for an investor making significant capital gains (above the annual allowance, set at £8,880 for the current tax year), they can also be a cost effective way to make regular smaller contributions over the longer term. Even if your portfolio is modest today, small sums invested over ten years or more – if invested well – can become a significant portfolio by the time you are ready to cash it in.

For an ISA to be a useful way to make regular smaller investments the charges to manage it and trade within it must be low. Luckily, with the large number of providers competing for retail investor business there is plenty of choice and some very low charges are available.Up to questions

Tax advanatges of ISAs

Within an ISA, gains on invested funds are tax free and there is no further tax to pay on any income received from dividends or other sources.  Thanks to this tax-advantaged status, ISAs do not even need to be reported on your tax return.

Up to questions

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