One of these is a Self-Invested Personal Pension (SIPP). This is a pension whereby you pay in money and benefit from tax reliefs, and you can then decide where you invest from a wide choice of investments.
Your age doesn’t matter, you’re free to transfer your pensions to a SIPP whenever you want to, and you can start a SIPP alongside any other pensions you already have, within the overall contribution allowances.
This gives you a lot of flexibility and control over your own pension, but there are four things you should bear in mind before you invest in a SIPP.
1. Tax benefits of a SIPP
As with other pensions, there are huge tax benefits that come with a SIPP. For every contribution that you make, the government adds 20% in basic-rate tax relief. So, if you pay in £8,000, the government adds a further £2,000. You can claim more if you’re a higher-rate taxpayer.
To receive this tax relief, you can only contribute as much as you earn each tax year, or £3,600, whichever is greater - up to £40,000 per tax year. Once the money is in your pension, it can grow without paying any tax.
2. Diversifying with a SIPP
In choosing investments for your SIPP - as with any other portfolio - it’s important to follow the principle of diversification. This simply means putting together a balanced spread of investments, not betting your shirt on one asset class and not putting all your eggs in one basket. You should avoid putting too much money into one industry, sector or geographical region, because if they perform poorly, so will the value of your whole portfolio.
On the other hand, in a carefully chosen and balanced range of investments, your exposure to one type of asset will be limited. Also, falls in the value of one, can be compensated by rises in another. Traditionally, the diversified investment fund approach has been to go for a 60:40 split between the two major asset classes - bonds and equities.
3. Investing into property with a SIPP
Another important asset class - which should form a part of any well balanced and diversified portfolio - is property. Property has traditionally been regarded as a relatively safe investment and, particularly in the UK, has performed well in recent decades. The rate of pace has varied, with peaks and troughs, but the overall trend has been upwards. The average UK house price in 1969 was £4,640, by 2007 this had risen to £223,405. It’s estimated that 300,000 new homes are required to be built every year, but only 178,000 were completed in 2016/17. With rising demand and limited supply, prices are likely to continue to rise.
Historically, small independent house builders supplied a significant proportion of the UK’s residential housing. However, the financial crisis and subsequent credit crunch and tighter regulatory environment for banks starved them of funds, and they withdrew from the market in large numbers. In fact, the numbers of small housebuilders – defined as those building fewer than 100 homes a year - registered with the National House Building Council halved between 2007 and 2014, to fewer than 3,000 – down from a peak of 12,000 in the late 1980s. These smaller independent builders supplied just under 20,000 homes in 2013, compared with an annual figure of almost 51,000 a decade earlier.
The government has recognised the vital role they have to play in resolving this housing crisis and it’s encouraging them to re-enter the market. However, these SME builders still struggle to raise finance from the banks. This provides an attractive investment opportunity, with builders looking for funds to help them satisfy a rising market demand.
As a result, developers and independent builders are increasingly raising finance through the issue of property bonds, often on online platforms. These property bonds are debt instruments, meaning that the investor lends their money to the issuer, who commits to repaying the amount loaned – the face value of the bond – when it matures, typically after between two and five years.
The bonds also pay interest, at a rate which is fixed, and the investor or holder of the bond may have the option of having the interest paid quarterly, or having it rolled up to be paid in total on maturity.
These bonds can provide a SIPP investor with a way of investing in the property market. However, it's important to consider that, following new rules introduced by the FCA from January 1st 2020 regarding the promotion of speculative mini-bonds, only experienced investors classified as either sophisticated or high-net-worth are eligible to invest into mini-bonds.
4. Risks and returns of SIPP investments
Another thing to consider before making your SIPP investment is the relationship between risk and return and your own personal attitude to risk.
Everybody wants to make a return on their investment, but generally, the better the potential rate of return an investment offers, the higher the risk is likely to be. For example, putting your money in a bank deposit account will only earn low rates of interest, but the money is safe. On the other hand, by investing your money into a start-up technology company, you have the opportunity of rich returns, but also the significant chance of losing some of your investment.
Different people have different attitudes to risk when it comes to investment - this depends on their circumstances, age and personality. If you have money you can afford to lose, you might be more inclined to venture it in a high risk investment. Somebody who is close to retirement will probably take a cautious attitude to defend the value of their savings, whereas a younger person, with time to make up for mistakes, might be more adventurous. People’s different risk profiles should lead them to take different investment strategies, and these will be an important factor in deciding the best investment for their SIPP.
Whilst SIPPs provide a great investment option for retirement, offering generous tax reliefs, it’s important to remember that you cannot access the money in your pension until you are at least 55. If you require access to your savings before this time in your life, then you may want to consider using an ISA for your tax efficient investments instead.
For individuals wanting to take control of their own pensions, SIPPs are a very popular choice. However, with this comes the responsibility of managing your own investments, and seeking the advice of an independent financial adviser before making any investment decisions is always advised.
The CARLTON Bonds product is available exclusively to experienced investors who are classified as either sophisticated investors, high-net-worth individuals or professional investors and have the knowledge and experience to make their own investment decisions. Investments are high risk and illiquid, your capital is at risk and returns are not guaranteed. Bonds are not protected by the Financial Services Compensation Scheme (FSCS).
Originally published 4th November 2019, updated 17th December 2019.