This week we take a deep dive into all things SIPP. What they are, why you might want one and why you might not. And I’m also going to run through a few alternative options that could make more sense for your particular situation.
To kick things off, I’m going to briefly go over pensions in general to see where the SIPP sits in the grander scheme of things.
What is a pension?
A pension is it kind of savings or investment plan with the aim of providing you with income when you retire.
If you don’t have one, then there is no time like the present to get started. Whether you end up with a SIPP or one of the alternatives we are going to discuss, in all likelihood you are going to need some money to fund your future.
The key for most people is deciding how much you need for a good retirement? And as we’ll soon see, that’s usually down to who you are and what you plan to do in retirement.
If you live in a cheap area with your partner, in a mortgage free house, are frugal, don’t like traveling, don’t need a car and spend most of your time indoors, you aren’t going to need as much as single person who lives in central London, rents a home, likes traveling, fine dining and driving classic cars.
But if you are looking for a number, some suggest the average person needs over £600,000 to have a comfortable life in the UK. Though, they don’t say as much, it looks like that number is based around the 4% rule.
Simply put, estimate how much money you need over the course of one year and then divide it by 4% to get your target pension pot.
For example, say I need £25K a year. Then that’s 25000/4%=£625K
Alternatively the Pensions and Lifetime Savings Association have gone into a lot more detail about how much you need to retire in the UK here.
(We’ve gone into a lot more detail about how much money you need to live in the UK here).
What kind of pensions are there?
There are lots of different kinds of pensions but they generally fall into three groups:
- Company
- State
- Personal
Company pensions are provided by employers, state pensions are provided by the state and personal pensions are provided by……..well…..you!
Company pensions
Under the Pensions Act 2008 all employers in the UK must place their employees into a pension scheme. The employer should also pay contributions in the form of automatic enrollment.
Usually you invest some of your salary into your pension scheme and your employer tops it up. The minimum contribution from each party (as of 6 April 2019) is 3% from you and 5% from your employer. Either side can pay more if they decide to.
Some big international companies might provide company pensions to employees when they move abroad. However, others won’t. If you are working for a company that provides you with a pension while you are living overseas then you are one of the lucky ones.
Even if you do have one, it might still be worth looking under the hood to make sure you understand how it works. A couple of key questions instantly come to mind.
- Are associated fees reasonable?
- Where do they actually put your money?
Overseas companies can contribute to a UK pension. However, the downside is that any tax relief is likely to be limited, or in many cases not available at all.
As a result, some UK expats choose to move their pension out of the UK. Often times they use a QROPS to do this. (We are coming to these).
The state pension
If you are a British citizen, the UK government should provide you with a pension when you reach pension age.
I’m always surprised by the number of UK expats I encounter that aren’t contributing to their state pension. It’s not going to provide you with a life of luxury but it’s practically free money. If you’re not making national insurance contributions now this should probably go straight to the top of your todo list.
In my experience, expats usually pay voluntary Class 2 contributions ( other classes are sometimes required depending on the specific situation). At the time of writing class 2 contributions are £3.45 per week. (You can see the latest rates here).
Just to add a layer of confusion into the mix, there have been some changes to the state pension announced recently. This means we now have two state pensions. There is the old one and the new one.
The old one is paid to people who reached pension age before April 2016 and the new one is for everybody else. Here’s the key difference you need to be aware of.
- New: £221.20/week – £11,502.40/year (more on the new state pension here).
- Old: £169.50/week – £8,814/year (more on the old state pension here).
Right now, (for the new one) you need at least 10 years of national insurance credits to get something and 35 years to get the full amount (it used to be 30).
You can start claiming the sate pension at 66, but this increases in the next few years to 67 and then 68. And expecting it to stay at 68 is probably wishful thinking!
Is the state pension a good alternative?
Of course, these numbers are always changing so by the time you retire it might be completely different, but right now I think it is a pretty good deal.
Based on the current situation, if you paid 35 years of voluntary class 2 payments you’d pay £6,279 in total.
The average life expectancy in Britain for men is 79 (Women is 83) so right now the average male could expect to receive 12 years of state pension. Based on current numbers, that means in total they could expect to receive just short of £140K.
You put in just over £6K and get back just short of £140K. That seems like a return on investment hedge fund managers would die for. You get it without the risk. I’m just saying……..
Not to mention the fact, you don’t have to do much of anything (apart from arranging your voluntary contributions!)
The only problem people who don’t live in the UK face is that it is not increased annually (as it is in the UK) unless there is a legal requirement to do so (which is unlikely).
Last I looked, there were just under half a million Brits abroad claiming their (frozen) state pension. Most of them were located in Australia, Canada and New Zealand.
Personal pensions
A personal pension is generally for somebody who doesn’t have the option of a company pension. For example many self-employed people have personal pensions.
A personal pension is straight forward. You pay in a set amount to your personal pension provider, just like paying money into a savings account.
The major disadvantage with personal pensions is that you don’t receive any contributions from somebody else i.e. your employer. However, if you can earn a lot more money by working for yourself or you get more freedom by working for yourself then perhaps that is a small price to pay.
With a personal pension you simply contribute as much money as you can over time leaving you with a pension pot for retirement.
In general most people spend their pension pot on an annuity. This is a fixed sum of money paid out to you until you pass away.
The amount you receive will depend on many things including the contributions you have made, the performance of any investments you have, and your own individual circumstances.
An alternative option to an annuity is called income drawdown. This is where your pension pot remains fully invested. You just take money out each year.
Income drawdown
In theory, this option has the potential to provide you with more money. However it is less predictable and comes with more risk because it ultimately depends on the performance of your investments.
Although the chances are you will have more money choosing income drawdown, you need to be aware that there is the possibility that you will have less. That’s because stock markets do crash from time to time. (Pensions are usually invested in at least some shares).
Right now personal pensions enable you to access your money anytime after your 55th birthday. This will increase to 57 from 2028. On top of that you can withdraw 25% of your pension pot tax free as soon as you are eligible to access your money.
In fact, if you wanted to, you could withdraw all your money in one go, although only 25% of it would be tax free.
The biggest advantage of a personal pension over either saving or investing yourself is that the government pays in an extra 20% in pension tax relief.
SIPP
SIPPs are a kind of personal pension. No surprise then, its an acronym for Self Invested Personal Pension. Generally, they can be considered a kind of do-it-yourself (DIY) version of traditional personal pensions that give you more control over your pension.
The main advantage is that you make the big decisions. You decide who you invest with and what you invest in. They are aimed at people who would like a hands on approach to managing their retirement investments.
As well as giving you more control, SIPPs give you more options. There is a vast range of assets that you can invest in compared to traditional personal pensions. The exact assets on offer will depend on your provider but in theory there are many investments for you to choose from.
You can invest in all of these:
- unit trusts
- government bonds,
- investment trusts
- insurance company funds
- some types off endowment policy
- some types of national savings and investment products
- bank and building society deposit accounts
- commercial property
- individual stocks
- open-ended investment companies (OEICs)
- exchange traded funds (ETFs)
Basically, you name it, you can invest in it.
There is also an inheritance tax advantage. If you pass away before your 75th birthday your pension pot will be passed on to your loved ones tax-free.
The money must be transferred to your beneficiaries names within two years to take advantage of this.
If you pass away after the age of 75 the money will be taxed up to your beneficiaries marginal rate of income tax. Having said that, your beneficiaries could reduce their tax burden by withdrawing money as income rather than in one lump sum.
Oftentimes, withdrawing small amounts every year will be charged at the lower rate of 20% rather than the 40% likely to be levied on lump sum withdrawals.
Fees
Just about all SIPPs used to be expensive, but not anymore. Nowadays there are some low cost products available. These low cost products don’t tend to give you as wide range of investment products as those products with higher fees, though.
And even the low cost options tend to come with additional charges, so are often not as cheap as they first appear.
Typical fees are:
- Initial set up fees: £0 to £500
- Annual charges: as percentage – 0.5%-0.75% or as a flat fee, of between £100 and £500
- Fund fees: typically 1.5%
As well as low-cost and full options there is one other choice on offer known as a hybrid or insurance SIPP. Each of which are slightly different investment propositions.
Full
Full SIPPs give you the widest choice of investment. You can invest in pretty much anything I listed above and more in some cases. This type of product tends to be suitable for people who have large pension pots, who want access to all investment assets on offer, or who want a lot of control over their investments.
Low Cost
Low cost SIPPs are cheaper but they generally provide you with limited investment choice. They are also inclined to be execution only.
With low cost versions you don’t usually have any help. You’re on you own!
Hybrid / Insurance
Hybrid or insurance SIPPs are provided by insurance companies. These typically require you to have a large amount money with the insurance company before you can start to choose your own investments.
Non UK residents
Non UK residents can usually only access SIPPs in two ways.
First of all, those who already have them can keep them when living abroad. You can’t usually add money, and if you can it won’t get the tax benefits but for some this doesn’t matter.
Then there’s the international SIPP or iSIPP.
What is an international SIPP?
These are UK based pension products aimed at non residents. They are similar to standard versions. The key difference being you don’t get the tax benefit if you live abroad because that’s for UK residents only.
Why you might not want one anyway
Unless you were sure that you were going to retire back to the UK in the near future, I can’t see why you’d want to open a SIPP. Let me explain:
That’s because a SIPP’s tax advantage and control aren’t really advantages for everyone, particularly if you live overseas. To get the tax advantage you need to be a UK resident.
I’m sure it goes without saying that people who live abroad aren’t usually classed as UK resident. If you aren’t UK resident you won’t be eligible for tax relief and this is the main advantage!
After all a pension is just tax sheltered investments. Usually, stocks and bonds.
The second key advantage of a SIPP is that you have a lot of control over your investments. That’s why you can often hear them described as a DIY pensions. It is a good description because you choose what to invest in.
The thing is, this is exactly what you do with DIY investing. It could be said that DIY investing is just like a SIPP anyway, but without the associated fees.
Dare I say it, I’m sure there are people out there paying fees that negate their tax advantage.
Even low cost SIPP fees are a lot higher than what you pay if you do it yourself. In many cases the tax advantage won’t counteract the fees you pay.
In other words, most SIPPs are going to be invested in a funds containing stocks and bonds and anybody with an investment account can invest in just the same way. The only difference is, investing yourself is nearly always going to be much much cheaper.
If you want to control your investments just invest yourself through a general investment account provided by an investment platform that’s open to non residents.
Fees fees fees
Keeping fees low is arguably the most important aspect of investing, because high fees can severely damage your investment returns.
Often people get mislead into thinking the fees they are paying aren’t expensive at all, but here’s what Charles Schwab, the founder and Chairman of Charles Schwab Corporation (one of the first and biggest discount brokerages) has to say during an interview with Tony Robbins in Money Master the Game:
“For every 1% over the lifetime of investing, it’s 20% of your money you’re giving up. Give up 2%, that’s 40%. Give up 3%, that’s 60%.”
Charles Schwab
And as for tax, remember, non residents do not pay capital gains tax on the sale of investments anyway. Not to HMRC anyway.
And while there are income tax payments to make, UK expats are still eligible for the personal allowance so unless you have a large UK income (i.e. from rental property for example) dividend and interest from investments will probably be tax free.
Not to mention the fact that, after five years living abroad you only usually pay income tax on buy to let income. Other forms of income are left alone. (We’ve talked more about tax here if you are interested).
Why you might want one
If you already have a SIPP that you are happy with that doesn’t go overboard on fees then keeping hold of it probably makes sense. Similarly, if you expect to go back to the UK in the near future it just might make sense.
Otherwise, for a lot of people it may be more sensible to invest yourself.
DIY investing
DIY investing means using an investment platform to invest in stocks and bonds yourself. SIPPs and QROPS (which we are coming to next) are really just investing with tax benefits anyway. It used to be difficult and expensive to invest yourself, but that isn’t the case anymore.
As well as avoiding high fees, another massive benefit with DIY investing is you have even more control over your nest egg. Not only can you can decide what you invest in, but perhaps more importantly to some people, you can also access your money at anytime. With the alternatives you have to wait until you are 55 (and that figure is on its way up in the near future).
It’s almost becomes a no brainer if you live in a low tax country.
Exchange traded funds (ETFs) let you put strong globally diversified investment portfolios together in a tax efficient manner anyway. Just about anybody can do it!
QROPS
You may hear a QROPS being a good option for non residents.
There’s some truth to this.
Basically, a QROPS is a pension that is transferred from a UK scheme to an overseas alternative.
QROPS stands for Qualifying Recognized Overseas Pension Scheme. It is something similar to a SIPP but they are based outside the UK.
The name refers to its relationship with HMRC.
Being qualified and recognized by HMRC doesn’t mean these aren’t without risk however.
All a QROPS really needs to do to become a QROPS is meet HMRC criteria.
And just in case you are thinking that sounds reasonable enough. It isn’t always.
The bottom line is, that it is a self certification process, rather than a process where HMRC get involved. As a result, you must do your due diligence and speak to a good financial advisor if you are considering a QROPS.
Unfortunately, it is pretty common knowledge that expats (especially British) are often exposed to unscrupulous practices. Here are three articles worth reading if you aren’t aware of this:
QROPS benefits
There are some benefits with QROPS. Like the ability to take up to 30% of your fund in a lump sum, receiving your pension in the currency of your choice, and depending on where you live and where the jurisdiction of your QROPS lies, the growth of the fund can be tax free.
But just bear in mind, DIY investing also has those benefits. The difference being you can withdraw 100% of your money at any time.
The biggest benefit of QROPS used to be related to the lifetime allowance (LTA). Government legislation which came into force recently has got rid of that one.
This means you are basically left with two advantages.
- You can move your existing pension pot outside the UK without getting a big tax charge
- QROPS avoid inheritance tax
But its worth saying that you’ll probably get something similar with an international SIPP for lower costs.
Offshore bonds
Another alternative you sometimes come across are offshore bonds. We’ve written in detail about these here, if you are interested but here’s the conclusion we came to.
Offshore bonds may enable you to grow your wealth in a tax efficient manner and provide you with tax free income. But and it’s a big BUT they aren’t suitable for everyone and they come with risks, especially for British expats. If you are considering investing in an offshore bond, make sure you do your homework, know who you are dealing with, understand exactly what you are investing in, be fully aware of what the charges are and recognize why offshore bonds make sense for you. And unless you are extremely financially literate, we’d recommend getting some financial advice.
British Expat Money
Foreign pensions and foreign tax sheltered savings
A final option would be to invest in some kind of pension or tax wrapped product in your country of residence if such a product is available.
The UK isn’t the only place to offer savings with tax benefits, so if you live in a country, which offers such products, and the local financial system offers good conduct, why not invest locally?
Where can I get financial advice?
If you want general free advice it’s always a good idea to start with the Money Advice Service. We often refer back to them on this site. Basically, it’s a free government backed website full of information on everything finance related.
The DIY approach works for most people, most of the time, but it’s not for everyone and certainly not all of the time. If you think you could do with speaking to a financial advisor we’ve talked about how you can go about finding one here.
The bottom line
If you already have a SIPP with low fees, that you can hold onto and you don’t intend to make fresh contributions then just keep hold of it.
If you must get your existing UK pension money out of the UK then a QROPS may be the way forward (but get some regulated financial advice before you take any action).
If the country I lived in had some kind of alternative pension product or tax sheltered account I might be tempted to go with that.
But for most people, most of the time DIY investing is probably going to make more sense. This is particularly true if you live in a low tax destination.