- What is a SIPP and how does it work
- How to save money in the form of tax breaks
- Who are the best SIPP providers
- How to pool your pensions together under one roof or just invest from scratch
- How generally to use your SIPP
- If you open a SIPP, what to invest in
- Step by step advice and resources that you can access
- Managing fees and avoiding needless losses because you don’t understand how to invest
SIPP Investing 101 – How to start your self-invested personal pension account today
1. What is a SIPP and how does it work
A SIPP stands for “self-invested personal pension” and it is an account that is backed by the government for self-managing your pension investments. Rather than forcing you to be subject to a mandatory pension scheme provider who makes your investing decisions for you, this account is a powerful tool that allows you to pool together your pensions into one place, and to make personal decisions on what to invest in.
Imagine it as a sort of ‘pension ISA’ where you get tax advantages for saving towards retirement, but you cannot access the money before 55.
The benefits are not simply the ability to self-manage your pension: in fact, one of the primary reasons for opening a SIPP account is to take advantage of the generous tax-breaks that the government currently gives for deposits that you make into a private pension. I cover this below in the next section – they are even more generous than your average employer’s pension!
You can contribute up to 100% of your annual earnings with an upper limit of £40,000 for the 2019-2020 tax year. That includes workplace pension contributions. If you are a salaried worker earning more than £150k then you need to be aware that your allowance tapers as a result of the cash you earn above 150k at a rate of £1 less allowance for every £2 above £150k that you earn
2. How specifically to save money in the form of tax breaks
I don’t think enough people take advantage of the free money available from the government in the form of pension tax relief. It is as simple as that: the government gives you free money for investing and saving towards your own future using a SIPP account.
If you are a basic rate tax payer (20%), then by paying in £800, you will receive £1000 in the SIPP account.
In other words the government puts £200 that you originally paid in tax – extra – into your pension, to save and invest for retirement.
If you are a higher rate tax payer (40%), then by paying in £600, you will receive £1000 in the SIPP account and returned to you through your tax code.
In other words the government puts £400 that you originally paid in tax – extra – into your pension and also returns a portion to you through your tax code, to save and invest for retirement.
This is a very generous policy and Frugal Investors are strongly encouraged to make the maximum contributions that they can afford, up to the current annual maximum of £40,000 per year.
3. Who are the best SIPP providers?
In order to take advantage of a SIPP you need to open a SIPP account. Imagine this like a cross between a savings account and a stocks & shares ISA. The account holds the money you deposit until you are eligible to withdraw it at age 55 (57 from 2028). There are a number of established providers who have large pools of clients and established ways of working. We have excluded Hargreaves Lansdown (an industry favourite) on the grounds of cost.
It is also important that they are covered by the Financial Services Compensation Scheme for up to £85,000. The FSCS is backed by the government and it’s an important protection in the event your provider went bankrupt.
Recommended Providers:
1. AJ Bell Youinvest – Low cost and established provider with competitive fee structure
AJ Bell offer SIPPs, Stocks and Shares ISAs, Lifetime ISAs and accounts for kids. In general this provider is a good balance between cost effectiveness, good service and access to all of the amenities you would need to manage an investment account.
For further details on fees see here. The standing charge is 0.25% per year with a maximum of £25/quarter. That fee is lower for £250k accounts and £1mn accounts. Buying and selling funds costs £1.50 and shares £9.95.
Assuming you have £45k and invest once per month into a single fund or ETF this would cost you £130.50/year (if you buy funds). That works out to 0.29% per year for a £45,000 account.
2. Interactive Investor also offer the full range of accounts and they have a structure that is setup to cater to slightly larger accounts of about £75-85k+
For further details on fees see here. There is a fixed charge of £10/month for SIPP accounts and £8/trade for UK shares and funds.
Assuming you have £45k and invest once per month into a single fund or ETF this would cost you £216/year. That works out to 0.48% per year for a £45,000 account, and 0.29% for a £75k account.
There are two important points to take away when choosing a provider. Estimate how much money you are going to have in the account, then as we have done above, figure out what your fees will be. Remember that the above calculations are for trading once per month, to effectively top-up your investments monthly. There is a lot to be gained from having the discipline not to trade too often.
In addition, there are stocks and shares providers like Robinhood that have come out in the United States (a very developed share market) offering free trades. Expect this to have an impact in the U.K. over the next decade – fees should come down and eventually go to zero.
4. How to pool your pensions together under one roof or just invest from scratch
When you choose a SIPP provider and you open up an account, one thing that you need to be thinking about is what to do with all of the pensions that you currently have. You can fund your new SIPP account with monthly deposits (to take advantage of tax breaks) and you can transfer in old pensions from previous schemes you contributed to.
Thankfully the UK passed legislation to force banks and pension providers to have a simple transfer-in scheme. You can find standard forms from your new SIPP provider (example here) that you can quickly and easily send to your old pension providers to instruct them to transfer the funds to your new SIPP account. This takes a bit of work: if you have a spare 30 minutes over lunch at work, you can normally crank through one of these forms and move an old pension to your new account. End-to-end it probably takes about 6-8 weeks.
There’s only one caution: make sure that you check with your old pension provider that you don’t have a final salary pension or any specific benefits that you would lose by transferring. Also make sure that they don’t take any major penalties for moving the money. In general I have found that pension providers try to confuse you into staying with them, so it is a bit like transferring your mobile phone contract: do so with conviction!
I moved 2 previous pensions into my SIPP account and now I self-manage those funds on a monthly basis. My current workplace pension cannot be transferred, so I continue to contribute to it, and when I eventually move from my current employer, I will transfer that pension to my SIPP.
5. How generally to use your SIPP account
I strongly recommend getting into good financial hygiene and using your account on a monthly basis. Unless you are retired and investing can become a ‘full time job’ for you, then avoid trading directly in stocks & shares. It will be an enormous time burden and often will not add to your performance significantly. Get in the habit of depositing into your account monthly (or via standing order weekly if you’re paid weekly) and then buying a Fund or ETF. For suggestions on what to invest in see Step (6) below.
Those deposits will be matched by 20% contributions from the government. You will receive those contributions, directly into your new SIPP account, every 1-2 months when HMRC credits the money to the provider. Higher rate tax payers will get the other 20% returned to them through their tax code.
Once that is working for you set yourself a time each month when you execute your investing strategy. Ideally setup a regular deposit on say the 15th of the month when you get paid. After the money is credited to the account either login to it and place the trades directly or setup an automatic order for purchasing more of a Fund or ETF.
6. If you open a SIPP, what do you invest in?
We cover investing strategies separately. There is a general rule of thumb, though, that you would be wise to follow. Do not rush to invest in the tens of thousands of stocks, equities, REIT’s, ADR’s, bonds, fixed income funds and other instruments at your disposal. Start basic with a passive investing strategy and build your knowledge. Be diversified and follow established methods for investing that set you up for the long term. If you need your money within 5 years, then don’t invest it to begin with. This whole enterprise is for the long-haul!
Have a look here for the Home Base Portfolio with a focus on Europe and the UK.
We have passive portfolios for following the MSCI World Index that are worth a closer look.
Finally the 5* Gold Rated Vanguard Asset Allocation ETFs are a staple for many portfolios and provide a simple, direct option for investing in the financial markets in a balanced way. This article takes you through how you could retire 13 years earlier just by pooling your pension funds and reducing the fees that you pay on them.
7. Step by step advice and resources that you can access
There’s a wealth of advice and resources that you can access on this website. Our goal is to support you with understanding how to gain access to the financial markets without taking on excessive risk, paying expensive fees, and getting trapt in assets that consistently under-perform the market.
For an article on managing your risk tolerance and deciding on how much to invest in the first place, have a look here. Deciding how much of your hard earned net worth to put to work in the financial markets is important and needs to enable you to sleep soundly at night!
The main providers of SIPP accounts have detailed information on how to access, use and manage the accounts. They are generally provided online for trading stocks & shares, topping up your account and managing it.
For further information regarding taxation, inheritance policies, and what your entitlements are at 55 contact your chosen SIPP provider.
In relation to receiving tax relief for higher rate earners through your tax code the method is remarkably easy. Call HMRC once per year and declare to HMRC how much you have contributed to your SIPP account. You will have receive your higher rate tax relief (the other 20% tax relief) back through your tax code. For further information contact HMRC
8. Managing fees and avoiding needless losses because you don’t understand how to invest
I am going to outline why we advocate a simple, passive investing strategy rather than owning shares directly. Remember you can buy ETFs that in turn invest in stocks directly for you. You can also do this in exactly the same way as a pension (see here).
The problem with investing in stocks & shares directly is as follows.
- You deposit £10,000 into a SIPP & Invest in One ETF
One way of approaching this would be to invest all £10,000 in a single ETF, like the Vanguard LifeStrategy 60% Equity Fund (ACC). It costs you £1.50 to make the trade (because it is a fund) and 0.25% per year with AJ Bell (£25) as a management fee. If you log in once per month and top it up, it costs £1.50 per month to add to the account and invest in a globally diversified list of thousands of businesses. Simple, cheap, effective.
- You deposit £10,000 into a SIPP & Invest in 25 individual stocks
If you go down the individual stocks route you require (to be safe) at least 20-25 individual stocks and shares that you identify and split your money between. Let’s say it takes you about 50 hours of research and you identify 25 stocks that you want to buy. Well, you have a simple problem: it will cost you £9.95 per trade, which for 25 stocks, works out to £248.75 to buy those stocks. Plus the £25/year management fee. Then to maintain this pool of 25 shares it will gradually cost you about 3 trades a month to constantly top-up the 25 shares you have with the new money that you add.
In effect you would suddenly be spending about £607 per year trying to manage that portfolio. That works out to almost 6% per year in fees and costs! It is for that reason you often hear the advice that passive investing is a better strategy. Unless you have £200,000, then the cost of buying and selling shares will form a significant percentage of your portfolio and it is not worth the risk.
The passive portfolio in effect enables you to join a £ billion pool of investor money, which makes the fees that the fund pays each day to trade (as investors deposit money and buy more shares of the underlying Fund or ETF) a much smaller percentage of the total funds available. It’s a more efficient asset allocation strategy.
The key is to find a set of investments that you understand (See Section 6) and that you are bought into owning for the long term.
Summary
Learning how to master your pension is a key cornerstone of financial independence!
There really is a way to have an efficient, well-managed SIPP pension, where all of your workplace pension funds are pooled together at a lower annual cost. We recommend that you deposit money into your SIPP regularly, take advantage of the free tax relief from the government, and responsibly invest that money in a balanced passive fund. In comparison to your average private pension and the fees and performance on offer there, this could mean that you retire up to 13 years earlier.
