What Is a Self-Invested Personal Pension?
Self-invested personal pension (SIPP) refers to a tax-efficient retirement savings account available in Great Britain. SIPPs give individuals the freedom to allocate their assets in a wide range of investments approved by the country’s Her Majesty’s Revenue and Customs (HMRC), a non-ministerial department of the U.K. government responsible for tax collection and the payment of some forms of state support. Approved investments include stocks, bonds, mutual funds, and exchange-traded funds (ETFs).
This is in contrast to company-sponsored pensions, where the company chooses a short list of investment options. SIPPs were introduced in 1989 and have become increasingly popular in Great Britain because of the end of lifetime careers and lifetime final salary pensions.
Understanding Self-Invested Personal Pension (SIPP)
The self-invested personal pension illustrates some of the differences between retirement plans in the U.S. versus Great Britain. In the U.S., retirement plan tax relief works in one of two ways. The first option is to invest pre-tax dollars, enjoy tax-free growth within the account, then pay taxes on withdrawals, as with a traditional IRA or 401(k). The second option is to invest after-tax dollars, enjoy tax-free growth within the account, and withdraw money tax-free, as with a Roth IRA or Roth 401(k).
The U.K.’s SIPP employs a third option. It adds to individuals’ contributions at a percentage based on their marginal tax rate. With basic tax rate relief, the federal tax agency adds 25 percent to the amount individuals contribute to a SIPP. For example, if an individual is in the 25 percent tax bracket and contributes £4,000 to a SIPP, the government will add £1,000 under basic tax rate relief, and the individual’s total contribution will be £5,000. The UK’s highest marginal tax rate is 45%, so SIPPs can offer tax relief as high as 45%.
SIPP Fee Management
As with other investment accounts, managing self-invested personal pension fees is important. Individuals should see whether a SIPP charges a fixed annual fee, a percentage of the portfolio value, trading commissions, or other fees before opening an account. It is important to choose a low-fee option to avoid harming long-term investment returns. For example, a fixed annual fee might be cheaper for someone with a high-value portfolio than an annual percentage fee. Account holders can manage SIPP investments themselves online or hire an investment manager.
Withdrawals From a SIPP
Individuals participating in a self-invested personal pension are free to start withdrawing funds beginning at age 55, even if they are still employed. Typically, individuals can take up to 25% of their funds tax-free. The rest is taxed as income. Notably, once funds are deposited in a SIPP, they can grow free of U.K. capital gains and income taxes. Tax benefits depend on the individual’s specific circumstances.