Self Invested Personal Pensions (SIPPs)

SIPP stands for self-invested personal pension and, as the name suggests, it's a type of DIY personal pension where you pick the investments yourself. You can think of it as being a bit like a self-select ISA, in that it's just a wrapper into which you put investments and, like ISAs, there is no Capital Gains Tax to pay on profits.

The difference is that SIPPs are basically subject to the same rules as personal pensions. They have the same limits on contributions, the same 25% restriction on the tax-free lump sum on retirement and the same requirement to buy an annuity by the time you reach 75.

Sipps allow savers to invest in a range of assets, from shares, gilts and bonds to investment funds, commercial property and -racier derivative-based products, such as contracts for difference (CFDs). These allow investors to bet on stocks falling in value or to hedge against share prices moving against them.

Until fairly recently, most Sipp holders used the wrapper as a way of drawing down on the income in their pension plan and to avoid taking out compulsory annuities. As a result, the average age of Sipp investors was very high and the sums invested were substantial.

But growth in the market has pushed the average age down and many more younger investors - in their 40s and 50s - are taking over the management of their pension pots. That also means that funds of £100,00 or less are increasingly common, fuelled in large part by the growing number of low-cost Sipp providers (especially the arrival of online SIPPs with far lower charges).

From next April, the investment rules affecting Sipps are to be relaxed still further, allowing investors to put residential property into a pension for the first time. This will allow the nation's army of buy-to-letters to get up to 40 per cent upfront tax relief on these investments. This will also apply to those buying holiday homes, either in the UK or abroad. The new rules will also allow people to invest in "alternative investments" such as wine or art through a Sipp wrapper.

In the next tax year, the list of assets permitted inside a self-invested personal pension (Sipp) is being extended. This will be investors' first ever chance to shelter residential property inside a pension structure and, if you are thinking of investing in property and holding it for the long term, then delaying a purchase until April could make sense.

The new rules are certainly enticing. Higher-rate taxpayers will qualify for 40 per cent tax relief on property purchases, so the net price tag on a flat that costs £200,000 would be just £120,000. There will be 100 per cent capital gains tax exemption on property disposals, and no income tax to pay on the rental income.

You will not be allowed to borrow more than half the value of your pension fund to purchase a property investment, but there is nothing to stop you borrowing money, or remortgaging your main home, and putting the money inside your fund to boost its buying power. However, the costs and risks associated with doing this would usually outweigh the benefits.

An alternative to borrowing money is to build up a large enough fund using each year's contribution allowances. Contributions into your pension will be limited to £215,000 initially, or to the level of your annual earned income.

Residential property outside the UK will also qualify for tax relief, but rental income may be taxable in the country where the property is located. But this may not deter investors. According to Assetz, a property investment specialist, France is one of the best places to invest money: deposits are small, yields are stable and capital gains large. It believes that total returns on cash invested in France amount to 92 per cent.

Not surprisingly, given the current obsession with property investments, there has been a huge increase in the number of people taking out Sipps. Standard Life, has already taken £1bn in assets since it launched nine months ago which means that it has been taking over £100m a month since launch last December (2004). To put this figure in context, this is almost half of the premiums invested in stakeholder pensions across the entire industry last year.

But for novice Sipp investors the variety of different charges levied can be daunting.

At one end of the scale are "low-cost" Sipps which generally have no start-up fees or ongoing administration charges. But as a rule they do not allow investors the opportunity to diversify into commercial property; most are restricted to collective investment funds and direct shareholdings. Some also insist that investors place a certain amount of their portfolio in the providers' own funds.

Most of these Sipps are aimed at consumers who are confident about making their own investment decisions. Investors will be expected to pay for advice.

At the other end of the scale is the "full" Sipp, which allows far wider investment choice.

Consumers opting for a full Sipp can usually expect to receive tailored investment and pension advice and portfolio management services. But these Sipps do not come cheap - basic administration charges can be as high as £500 year and there are often additional service charges to pay. For those with smaller pension funds this is clearly uneconomic.

Some online stockbroker SIPPs charge lower fees in exchange for limiting the range of potential investments you can choose from. For example, low-cost plans are unlikely to permit the purchase of property, though given the restrictions in this areas, you need a substantial fund (say £100,000) before this is a realistic proposition. While full-service SIPPs often charge annual fees of over £500 (with transaction fees on top), online stockbroker SIPPs may charge only £100 a year.

"This means that the ability to control pension investments by choosing where to place their money across a wide range of assets will no longer be the preserve of the wealthy."

The main difference between Killik's product and the other low-cost Sipps on the market is that investors get free tailored investment advice. Hargreaves Lansdown, for example, similarly has no start-up fees or ongoing administration charges. But those looking for investment advice will have to pay for this service.

So how do the likes of Killik and Hargreaves Lansdown make money from Sipps? It is important to remember that low-cost Sipps are not completely free. All Sipp providers make some money from dealing charges and stockbroking fees. For example, Hargreaves Lansdown charges £9.50 for buying or selling shares or funds worth less than £499. For deals worth between £500 and £1,999, the charge is £14.95.

In contrast, Killik charges 1.65 per cent of the value of deals up to £15,000. For larger transactions the fee reduces to just 0.5 per cent, with a minimum commission of £30 on share deals and £40 for funds.

Whereas some providers, such as Hargreaves Lansdown, will offer discounts off the initial charges on unit trusts, other providers will charge the full 5 per cent fee and pocket a proportion of this as part of their dealing costs.

Nick Arbin is an independent pension consultant who works for The Pensions Partnership, a firm of IFAs spec-i-alising in pension advice. He says no one Sipp offers the best solution for everyone - much will depend on your personal circumstances.

"Many people are unhappy that all their pension is in one managed fund, run by an insurance company with mediocre performance. They just want to access the full range of funds on the market," he says.

For these people an online or low-cost Sipp is often ideal. However, Arbin warns: "Do check the dealing costs and make sure there are no restrictions insisting you invest a minimum amount in the company's own funds."

He says certain insurers, such as Clerical Medical and Eagle Star, have offered "free" Sipps that require investors to place £50,000 in their own managed fund.

"Obviously, this is not free," says Arbin. "Rather than charge an administration fee, they are ensuring they get this money from management charges on these funds. But the point of a Sipp is to give you wider investment choice, not to end up with the lion's share of your portfolio in one fund."

For those with larger portfolios a full Sipp may prove a more cost-effective option, he says, particularly those who want tailored investment advice and portfolio management services. "If you have a pension worth £1m then whether you pay a fee of £100 a year or £500 a year is largely irrelevant. What becomes more important is the level of service offered."

However, a word of caution for those looking to move existing funds into a Sipp. Most advisers warn that it can take up to eight weeks for insurance companies to complete these transfers.

Philip Brown, the director of marketing at Killik, says: "We have found the average to be about four to five weeks, though in many cases it is taking far longer."

He cites one example where Norwich Union took eight months to complete a pension transfer.

Other advisers agree that insurers' transfer systems leave a lot to be desired. Arbin says: "In many cases it can take up to eight weeks simply to get an up-to-date pension illustration."

While these delays may prove frustrating, they could also prove costly next year for investors.

SIPPs can invest in:

Tax benefits:

Sipps, in a nutshell:

 Self-invested pensions now into CFDs

 More on CFD SIPPs

 Pension Diary