Pensions used to be a catatonic subject just discussed with financial advisers and human resources staff.
Since the introduction of freedom and choice for retirement money four years ago, it has become a hot topic.
No one today would recognise Samuel Johnston’s quip that a pension is “generally understood to mean pay given to a state hireling for treason to his country”. Yet the current state provision of £168.60 a week, akin to £8,767.20 annually, is unlikely to maintain one’s lifestyle.
Pensions are incredibly tax efficient and should be the bedrock of most retirement plans. However, there are tax implications and charges if you invest excessively, if the fund becomes too large or too much is withdrawn at an early stage.
For example, the first 25 per cent from a pension fund can be drawn tax-free but the rest is subject to the investor’s marginal rate of income tax.
The starting point for those in employment is likely to be a company pension scheme. Most offer a fair range of investment options and competitive charges plus, with auto-enrolment, contributions by employers.
The major alternative is a self-invested personal pension or SIPP. This is just a tax wrapper with a range of choices, broadly split into a basic low cost vehicle into which funds and shares can be built up or a more expensive version permitting a wide range of products.
Decide if you want limited choice or would benefit from the extra flexibility and investment range of the latter.
Demand for SIPPs has exploded over the last decade as investors like to take control of their retirement outcomes. From just 12,941 sold in 2007, the number is now over 800,000 annually.
Many are attracted to the inheritance position. If the SIPP investor dies before 75 years, the whole pot is passed on tax-free. Above this age, the SIPP can continue growing but any withdrawals by beneficiaries are subject to their personal tax rate.
Although the title is “self-invested”, in fact anyone can use an independent financial adviser to guide or make the decisions. Non-SIPP pension funds have a modest record: growing 15.7 per cent in 2016 and by 10.5 per cent in 2017 but falling 6.2 per cent last year.
Use an IFA to help select the SIPP provider who should not only offer the range likely to be used but be strong and secure. Following the failure of several providers and the near demise of others, the FCA as regulator decided firms should be required to hold sufficient capital as a safeguard.
A provider that can easily pass the test for capital adequacy clearly gives the investor more security.
Provider should be able to accurately and fairly value assets and ensure that securities are traded and, if necessary, could be realised within 30 days.
Some SIPPS have been rightly criticised for the poor returns within them, resulting from a few providers who found it too tempting to open their doors to dubious investments to gain high paying accounts on their books.
These were largely unregulated scams aimed at unsophisticated savers with relatively small funds. A more cautious approach by other providers avoided or limited exposure to non-standard assets.
The debate continues as to how far the industry should allow a small number of investors with the knowledge, experience and appropriate risk profile to make choices outside the norm, perhaps in unlisted shares or ethical funds that cannot be ordinarily accessed.
With a commercial property in a SIPP, for instance, the provider needs to have experience, and to know what action is permitted. If there are insufficient funds available to make such a purchase, the provider should know that the SIPP may be able to borrow up to 50 per cent of the net asset value.
For a very basic SIPP, Aegon permits just open-ended funds to be placed in its simplest version with no fees to open or transfer cash and charges just 0.26 per cent up to £100,000.
Among those offering a full range (including commercial property, convertible securities, future and options, investment trusts, warrants and unquoted) are City Trustees (set-up £280 plus £470 annual), Mattioli Woods (£895 set-up plus £679 annual) and Westerby (£310 set-up plus £560 annual).
Diversity in a SIPP is sensible, notably a portfolio of shares, fixed interest and, if it meets your financial objectives and attitude to risk, commercial bricks and mortar.
It is also a useful way to consolidate different pension funds, notably where there are several policies.
A SIPP is not so appropriate for those with little or no investment knowledge or with less than £50,000 and/or low contribution levels, as well as savers who do not require a wide investment choice.
Kelly Kirby, chartered financial planner at advisers Chase de Vere in Leeds, says “those who are starting out with a pension and have decades until their planned retirement should be taking a high degree of risk to achieve the best long-term returns”.
This is particularly the case when making regular payments as this removes the worry over market timing and the route should be mainly into shares.
For those closer to retirement, if planning to buy an annuity, reduce volatility by opting more for cash and fixed interest.
Those intending to draw down their pension by instalment should hold more in shares and funds so that there is still good growth potential, particularly if in good health and the money is to be used over two to three decades.
Even if using a SIPP to build up a retirement pot, do not ignore an annuity as it will provide a guaranteed income for the rest of life. Yet, upon death, the annuity stops and the pension provider takes the money that it had expected to pay out, unless the policy has been written on a joint life basis.
By comparison, the unused assets in a SIPP can be passed to children. If considering opening a SIPP for a youngster, several providers have no minimum age including Alltrust, Bank of Scotland, Barnett Waddingham, Carey Pensions, Curtis Banks, DP Pensions, Halifax, Hargreaves Lansdown, LV=, Pilling, Prudential, Rowanmoor and Standard Life.
Many providers have no upper age restriction to start a SIPP. According to Moneyfacts research, they include Aegon, AJ Bell, Aviva, City Trustees, Dentons, Killik, London & Colonial and Xafinity.
When looking at fees, two-thirds levy a start-up fee and almost all have an annual administration charge which may depend on the sum invested or the type of holding. Expect also to have charges for dealing, transferring assets and special fees for purchasing and selling property.