What are the tax-efficient benefits of a SIPP?

A Self-Invested Personal Pension (SIPP) is, basically, a do-it-yourself pension. Ideal for more experienced investors, a SIPP gives you the freedom to choose and manage your own pension investments.

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Most traditional personal pensions limit your investment options, and they’re usually run by the pension company’s fund managers, where you have little to no input on where your funds are invested. 

On the other hand, with a SIPP you can invest anywhere you’d like (as long as your SIPP provider allows). 

But you still receive the standard pension tax reliefs with a SIPP - including up to 45% tax relief on contributions, depending on your marginal rate of tax - while the extra choice gives you the potential to maximise returns, paving the way for a better retirement.


Making the most of your pension allowance

With a lifetime allowance of £1,073,100, an annual allowance of £40,000 and tax relief on contributions, pensions are one of the most tax-efficient methods of saving for retirement. 

However, there are some exceptions which could mean your pension allowance is lower. For example, if your ‘adjusted income’ is over £240,000 or your ‘threshold income’ is over £200,000, your allowance is reduced. 

To open a SIPP, you must be under 75. But the earlier you open and begin investing, the more time your capital has to grow - helping to maximise returns and minimise risk. 

Like most other private pensions, you can begin to withdraw from a SIPP at the age of 55.


Understand SIPP tax reliefs

Financial security in retirement is important, and pension tax reliefs are a great incentive to pay more into your pension. 

The tax reliefs you can benefit from with a SIPP include:

  • Income and capital gains tax-free growth

  • 20% tax relief on contributions for basic-rate taxpayers, 40% for higher-rate taxpayers and 45% for additional-rate taxpayers

  • Withdraw the first 25% as a tax-free lump sum 

For example, if you wanted to make a contribution of £10,000 into your pension, you would only have to contribute £8,000 - the government would then pay a further £2,000 of basic-rate tax relief into your pension. And if you’re a higher-rate or additional-rate taxpayer, you could then claim back a further £2,000 or £2,500 respectively.


Where to invest your SIPP to maximise returns

When opting for a SIPP, you have two top-tier options: invest in a ready-made portfolio or choose your own, individual investments. 

As previously mentioned, the ability to choose your own investments allows greater flexibility and visibility. However, with this flexibility, comes responsibility. You should only opt for this kind of SIPP if you are comfortable making investment decisions, and you have the time - and are willing - to manage your own investments. 

The good news is that when choosing where to invest your SIPP, you have a lot of options, including:

  • Shares. Owning shares means you have part-ownership of a company, and you can buy and hold shares in your SIPP. 

  • Bonds. Bonds are loans to companies or governments. 

  • Investment trusts. Investment trusts are similar to funds. However, they’re listed as companies on the London Stock Exchange (LSE), so they’re traded like shares. 

  • Funds. A fund is a collection of investments that are chosen and managed by a fund manager. 

  • Exchange-traded funds (ETFs). ETFs are a type of fund that tracks a stock market or commodity.

  • Cash. You’re able to hold cash in your SIPP if you choose not to invest straight away. 

You can usually hold the above in your SIPP, but your provider ultimately decides what assets you can hold, so be sure to check with them first. 


Pass on your pension tax-efficiently 

It’s important that you understand what will happen to your pension when you die, and in most cases, a SIPP can be passed on to your beneficiaries free from inheritance tax. 

You can choose as many beneficiaries as you like, and if you die before turning 75, they can usually withdraw what they like from your pension without paying tax. 

If you die aged 75 or older, withdrawals will be taxed as the beneficiary’s income.


How to choose your own investments for your SIPP

The principle behind SIPPs is that you will have access to the same tax incentives available to more established models of pension investment (income tax relief on contributions, tax-free capital gains, and the ability to withdraw a lump sum of up to 25% tax-free from the age of 55), but play a more active role in managing your investment. 

When choosing your own investments for you SIPP, it’s important to remember that diversification is key. 

Different types of investments and sectors perform well at different times - for example, during COVID-19 the technology and property were two of few sectors to have performed well due to the surge in demand.  Whereas other sectors such as travel and hospitality have not performed as well as a result of the pandemic.

That said, investments should be diversified across asset classes, industries and locations which allow investors to maintain a long-term view.

Diversification doesn’t eliminate investment risk completely, but it can help to shelter you when some areas of your portfolio don’t perform as well as others. To help spread risk, you could consider choosing a number of asset classes to be successful.


Tax-efficient investment alternatives to a SIPP

The Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) are two of the most generous tax incentives for experienced investors investing into high-growth, early-stage businesses. 

Introduced to stimulate entrepreneurship and encourage investment into unlisted businesses, they offer tax reliefs including:

The Enterprise Investment Scheme (EIS)

  • Up to 30% income tax relief. This is applicable on a maximum annual investment of £1 million* and in order to claim, you must have sufficient income tax liability and hold the shares for at least three years.

  • No capital gains tax when selling EIS shares. If you have held your shares for at least three years, claimed income tax relief and the company still qualifies.

  • Capital gains deferral. You do not have to pay capital gains tax immediately when using a gain from the sale of any asset to make an investment into an EIS-eligible company.

  • Inheritance tax relief. After being held for two years, EIS investments are eligible for Business Relief and become inheritance tax-free.

  • Loss relief. If your EIS investment is realised at a loss, it can be offset against the same or previous year’s income tax, or the same year’s capital gains tax.


Seed Enterprise Investment Scheme (SEIS)

  • Up to 50% income tax relief. Up to 50% income tax relief can be claimed on a maximum annual investment of £100,000. To claim, you must have sufficient income tax liability and hold the shares for at least three years.

  • 50% capital gains reinvestment relief. Provided you receive SEIS income tax relief,  you can offset any other capital gains from the same year up to half the value of your investment.

  • No capital gains tax on profits. You do not have to pay capital gains tax when selling SEIS shares as long as you have held them for at least three years, claimed income tax relief and the company is still SEIS-eligible. 

  • Inheritance tax relief. After being held for two years, SEIS investments are eligible for Business Relief and become inheritance tax-free.

  • Loss relief. If your SEIS investment is realised at a loss, it can be offset against the same or previous year’s income tax, less any income tax received. 


Read more: how to maximise returns and minimise risk through tax-efficient investing


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