Head of pension research, Hargreaves Lansdown
Tom McPhail, Hargreaves Lansdown
Key reforms to Self Invested Personal Pensions (SIPPs) are causing a stir. A pension expert explains the changes and the potential risks and rewards.
The pensions industry has managed to score some spectacular own-goals in recent years.
Even with the launch of the government inspired stakeholder pensions, with their simple structure and no hidden charges, all has not gone well and sales volumes have fallen well below original expectations since they hit a peak back in the late 1990s.
It seems pensions just aren't sexy these days.
Amidst all the mis-selling scandals and falling stock-markets there has been one notable success story.
Self Invested Personal Pensions (SIPPs), first launched in the early 1990s, were initially treated as a fringe product which appealed only to the more affluent and sophisticated investor.
There was some justification for this as charges were high and the administration systems supporting them were cumbersome and unwieldy.
As a consequence sales volumes struggled to rise above a few thousand a year.
In the last couple of years the picture has changed.
There are now reckoned to be around 100,000 SIPP holders in the UK, and the number is rising fast.
So what have SIPPs got that other pensions haven't?
The key difference is investment flexibility.
Your average insurance company personal pension or stakeholder plan will typically offer a range of perhaps 20 or 30 investment funds, with the more adventurous companies offering perhaps 70 funds.
By comparison a typical SIPP will give you the freedom to choose from around 1,000 funds, including those managed by the leading fund management groups.
In addition you can use a SIPP to invest directly in individual equities of your choice, gilts, bonds and commercial property.
The key argument against SIPPs in the past has been cost, with SIPP providers charging hundreds of pounds in upfront fees and ongoing annual fees.
These fees meant that SIPPs were only worthwhile for investors with substantial funds to play with, perhaps £50,000 or more.
But the advent of efficient administration systems and economies of scale mean that good SIPP providers can now offer a pension which delivers the investment freedom without the additional fixed fees.
As a consequence a SIPP is just as good value for an investor with £100 a month to save as it is for someone with £100,000 to invest.
SIPPs are still more expensive than a Stakeholder plan, but the difference is only a slightly higher annual management charge, perhaps 1.4% instead of 1%.
The payoff is access to the best fund managers in the market.
Over the 3 years in which stakeholder pensions have been with us, the most popular SIPP funds have consistently outperformed the major stakeholder funds.
From April 2006 SIPPs will get a whole lot more interesting.
Investors will be able to use a SIPP to invest in residential property such as buy-to-let and holiday homes.
Given the state of the housing market it is perhaps questionable whether people should do this, but we do expect demand for this investment freedom to be very strong.
As the Inland Revenue rules stand at present, it will be possible for investors to purchase buy-to-let properties and holiday homes with their pension fund, and then rent the property out to generate income for the pension.
This looks like a great idea, but there are a couple of pitfalls.
If the investor themselves stays in the property they will have to pay a tax charge to the Inland Revenue.
There are potential investment risks as well.
Nationally we already have much of our personal wealth tied up in the housing market, and the opening up of the housing market to private pension funds may simply encourage us to double up our exposure to the property market.
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