Choosing your first pension can be a tricky decision. John Fitzsimons looks at what needs to be considered before you take the plunge.
Ever since I became a financial journalist, my friends have always tried to pick my brains on almost anything to do with money, from what mortgage to go for to what they should do about their credit card debts.
But there is one subject that is never mentioned: pensions.
It's a shame, because getting the right pension might just end up being the most important financial decision you ever make. And as SIPPs - a type of pension - become increasingly popular, they merit particular consideration.
So why should you go for a SIPP? And what factors should determine which SIPP you go for?
What is a SIPP?
First, let's look at just what it is. SIPP stands for 'Self Invested Personal Pension' which is, as the name suggests, a pension where you have control of your pension pot.
By contrast, with a traditional pension, you hand over your money each month, and the provider manages where it goes, from a pre-agreed pool of investments.
A SIPP is simply a DIY version of this, where you have control over where that money goes.
Why would I want a SIPP?
It's that flexibility that is the main sales point of the SIPP.
It means that you can invest in things outside of the traditional pension remit - commercial property, individual and unquoted shares, a whole host of different things.
Of course this can be either a good or a bad thing - it really all comes down to the investment decisions you make.
You can either use your own judgement about where to invest, or take advice from a financial adviser. But the fact that your investments are not limited opens up the potential for far greater returns on your funds.
Why are SIPPs more popular nowadays?
It's not that long ago that the charges involved with running a SIPP meant they were only really the preserve of those with a large pension pot to play with. However, those charges have come right down over the last few years, so they are now an option for almost everyone.
The tax benefits of a SIPP
There are a number of tax benefits to a SIPP which make them very attractive. The first is that it can be used to avoid paying extra Inheritance Tax, though this remains something of a grey area.
In theory, if a person dies before withdrawing the assets from their fund, their family should be entitled to the money without paying Inheritance Tax.
However, this remains uncertain as it comes down to how the Inland Revenue judge the case. If they decide that you paid into the SIPP specifically to avoid Inheritance Tax, your relatives may still be hit with a bill.
In other words, so long as it does not appear that you know that you can benefit in this way from investing in a SIPP, you will be fine. Get your head around that one!
There is another great tax benefit, should you be a higher rate taxpayer. When you pay into a pension, the Government automatically tops this up with basic rate tax relief (which is currently 20%). In other words, if you pay in £8,000, the Government will pay in £2,000.
If you pay a higher rate of tax, then you can claim any higher rate tax relief that you are due via your tax return. In the example above, that equates to a further £2,000.
The money you pay into a SIPP is also exempt from Income Tax, while any profits from your investments avoid Capital Gains Tax, so tax-wise, a SIPP is a cracking option for most people.
How much does a SIPP cost?
As you get to choose where your money is invested, you might be wondering whether it really matters who provides your SIPP. Aren't all providers basically the same?
No, unfortunately not. Different providers levy a variety of different charges depending on the way you manage and invest your money.
For example, the set up fee for the SIPP can be anything up to £500. As a general rule of thumb, the more 'complicated' your investments - i.e. the further from mainstream investments - the more you will have to pay in terms of the administration and running of your SIPP.
The overall charges you are likely to face should be a significant factor when you decide which provider to go with.
As well as the annual charge, you may face a number of other charges, for example: an annual management fee; a dealing fee, incurred each time you buy or sell and investment; and a transfer fee, which you may be hit with when moving money from another pension or from the SIPP itself.
So which provider should you choose?
The low cost SIPP option
However, if you are just starting out with a SIPP, I reckon it makes far more sense to limit yourself to a low cost SIPP, at least until you have got the hang of how it works.
Thankfully, there are a number of these now available, and one of the leading ones is the Vantage SIPP from Hargreaves Lansdown.
Let's take a look at the charges. With this particular SIPP, there are no set-up charges or fund dealing costs. There is also no annual charge on the cash in the account.
As for investments, if the dealing amount is less than £500 then you will only pay £9.95 for each trade. This increases in stages up to £29.95, though this is only incurred if the dealing amount is in excess of a monstrous £20,000. This SIPP also offers healthy discounts on the fees you will face should you opt to put your money in investment funds.
This strikes me as a good place to start out with SIPPs, as you'll only need to invest £50 a month or £1,000 annually.
If you want to know more about low cost SIPPs, you might want to check out Five top low cost SIPPs
Making that SIPP decision
Personally, I would always prefer to discuss my options with a financial adviser, but the fact that you will have to pay for this advice might put you off.
Whichever route you choose, make sure you do plenty of research and shop around for the SIPP that is right for you. It may help you to read what my colleague and pensions expert, Jane Baker, decided to put in her own SIPP.
If you're only just starting out, you might want to stick to a low cost SIPP, and perhaps run a normal pension alongside it, to hedge your bets, at least in the short term.
It is also essential to ensure you understand when you are likely to face charges, and any limits on where you can invest.
A SIPP boasts some amazing benefits, and is now within the financial range of all of us. And it isn't necessarily all that complicated. Sure, if you want to devote time and energy towards getting the most out of your money, you can potentially have a lot of fun - and success - choosing different funds for your SIPP. But if you'd prefer not to spend much time on it, it's also possible to pick a simple, cheap index tracker, sit back, and (hopefully) watch your pension grow along with the market.
The choice, with a SIPP, really is yours....
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