Savers now have a much wider range of options when it comes to pension planning and framing a retirement strategy.
One of these is a SIPP, Self-invested Personal Pension. 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 and you can start a SIPP alongside any other pensions you already have, within the overall contribution allowances.
It 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 SIPPs
As with other pensions, there are huge tax benefits to a SIPP. For every contribution to your pot 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 tax payer. 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 each tax year. Not only that, but once the money is in your pension it can grow without paying any tax.
2. Diversifying with SIPPs
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 nest eggs in one basket. You should avoid putting too much money into one industry, or 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 of 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 the trend has been upwards. The average UK house price in 1969 was £4,640 and 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, which commits to repay 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 of having it rolled up to be paid in total at maturity. These bonds can provide the SIPP investor with a way of investing in the property market.
4. Risk 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.
Of course, everybody wants to make a return on their investment, but, generally, the better the potential rate of return that an investment offers, the higher the risk is likely to be. Putting money in a bank deposit account will only earn low rates of interest, but your money is safe. On the other hand, by putting 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, reflecting their different circumstances, ages and personalities. 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 will be an important factor in deciding the best investment for their SIPP.
A fixed interest property bond will typically give a better rate of return than cash, although not as potentially rewarding as shares ISA. In terms of risk, it also sits somewhere between the two, being less secure than a cash, but more secure than equities. In this regard, it should also be borne in mind that fixed rate property bonds are often secured against property assets, providing additional security.
However, even if a fixed rate bond is asset backed, an economic downturn could affect returns and you may not get back the amount invested. In the event of default the security held doesn't guarantee the return of your capital. Enforcing your security may take time and your returns may be delayed. Investment is not covered by the Financial Services Compensation Scheme (FSCS).