By Claire Court
Head of Self-Administered Pensions at independent financial advisors Origen
The government is planning to help you buy a second home for the benefit of your personal pension scheme.
It is all part of controversial legislation that comes into effect on 6 April 2006.
This affects self-invested personal pension plans, known as SIPPs.
Introduced in 1991, SIPPs give you more control over a personal pension than if you invest solely via a pension company.
From next year, even people in occupational pension schemes will be able to start one.
What is a SIPP?
A SIPP is a pension contract in your own name. You can decide where the SIPP is invested, subject to certain HM Revenue & Customs restrictions.
It can be set up with funds from existing pension arrangements, by making contributions, or from a combination of both. It is also possible for your employer to make contributions to your SIPP.
The new rules increase how much you can pay into your SIPP, with more freedom over where it can be invested and how benefits are paid on retirement and death.
Contributions & Tax Relief
Contributions to a SIPP are currently linked to your age and earnings. From next year, you can contribute up to 100% of earnings regardless of your age.
The maximum contribution each year from both you and your employer is capped at £215,000. And you can claim tax relief on contributions you make.
It is worth noting that people without earnings e.g a housewife or househusband, or even a child, will be able to benefit from a SIPP taken out on their behalf (by anyone) who can then contribute up to £3,600 a year.
From April 2006, you can invest your SIPP in a much wider range of assets. For the first time you can invest in residential property, antiques, fine wine and other chattels.
This will be in addition to the traditional asset classes such as cash deposits, quoted equities, collective investments and commercial property.
Investment growth is free of UK tax on non-dividend investment income. Rent is received tax-free and bank account interest is paid gross. There is also no capital gains tax to pay when an investment is sold by the SIPP.
By taking out a SIPP you are not making a once and for all decision.
SIPPS RULES EXPLAINED
Pension under your personal control
Investment decisions are yours
You take all the risk
Tax relief on contributions
April 2006-wider range of possible investments
If at some point you decide that a SIPP is no longer appropriate you can instruct the provider to sell the assets and transfer your fund as cash to another pension scheme.
This could be a new employer's scheme or a personal pension run by an insurance company.
You will be able to invest in residential property to either lease to a third party or for your own use. This could include buy-to-let properties, holiday homes and even your own home.
Your SIPP would even be able to purchase a residential property from you. The purchase price paid must be on open market terms.
The SIPP would be able to borrow to assist with the property purchase. The maximum borrowing from April 2006 will be 50% of our existing SIPP fund value.
You must remember that the property becomes an asset of the pension fund and hence the value of it will be used to provide retirement benefits for you.
You will normally be one of the trustees of your SIPP. The trustees have the responsibility to meet the health and safety regulations and the other obligations that fall upon the landlord.
These mean that the property must be properly managed otherwise your SIPP could be at risk.
If you or any member of your family wish to use the property you must pay the open market rent to your SIPP. Otherwise you would be subject to a tax charge based on the open market rent and value of the property.
You should be aware that the sale of any personal asset by yourself to your SIPP might mean that you have to pay capital gains tax on the proceeds.
As well as purchasing assets you are also allowed to sell them within the SIPP. If for example you buy a house and then at some point believe that you could sell it for a good price you are able to do so.
The sale proceeds would then be held in your SIPP ready for you to make another investment.
You should, however, make sure that you are not deemed to be "trading".
Otherwise, the Inland Revenue would tax the profit made by the SIPP and could ultimately take away the SIPP's tax privileged status.
It will be possible for your SIPP to purchase residential property overseas.
A suitable target for investment?
This means that you could purchase a holiday home abroad, although the same rules concerning paying market rent apply if you or your family use it.
There may be difficult issues regarding the overseas treatment of the property.
For instance, many countries do not recognise trusts and countries such as Spain and Portugal have developed anti-avoidance rules that make it inadvisable to hold property through offshore companies.
Buying overseas property will usually involve higher costs than dealing with UK property given the expertise that will be required.
Whilst your SIPP will be exempt from UK tax on the investment it may still have to pay tax locally. You could also possibly find yourself liable to foreign wealth tax.
Therefore, in some cases an overseas residential property may not be a suitable pension fund investment, particularly if it represents a large (or the entire) proportion of your pension fund. It will be illiquid and there is also a currency risk.
Retirement & Death Benefits
The new rules will give you more flexibility over how and when you draw your retirement benefits.
The earliest age you can draw benefits will increase to 55 from 2010, although it will remain at 50 until then.
Notably, you will no longer be required to purchase an annuity at 75.
Instead, you can continue to draw your income directly from the fund using Alternatively Secured Income (ASP).
Under ASP, the maximum income after 75 will broadly be 70% of annuity rates. The annuity rate used is always for a 75 year old regardless of your age, which means that over time your income is likely to reduce.
As a result, ASP is only suitable for those who can afford to live on a reduced income.
The upside of ASP is that on your death your spouse will receive a pension. On their death, the remaining fund can be reallocated to your children or grandchildren's pension funds.
For example the father could have a SIPP and elect to use ASP. On his death his widow would receive a spouse's pension. On her death the remaining fund in the SIPP would be calculated and reallocated to their three sons' pension funds as long as they are members of the same SIPP.
This would then form their own pension funds, from which they could draw a pension from 55 onwards.
This concept is known as the "family pension" and in years to come we will see pension funds cascading down generations of families.
One point to note though is that there will be an inheritance tax charge on the reallocation of funds. It is not yet known how much or how it will be applied.
Who might SIPPs be suitable for?
SIPPs may be suitable for a wider range of people than at present.
This includes entrepreneurs, self-employed professionals, senior business executives or just those who would like more involvement in the day-to-day running of their pension fund.
SIPPs can also join together to purchase assets, particularly property.
SIPPs are provided by a range of providers, including IFAs, stockbrokers, banks and insurance companies.
The charges, typically, are £300 to start one up and then £500 a year to manage it.
However there is an obvious danger with a SIPP.
There will be no one else to rely on if you make the wrong investment decisions. If your property falls in value or if your shares crash there will be no government nor employer to bail you out - the responsibility will have been yours and no one else's.
BBC News 24 are running a forum on Sipps at 15:30 on Thursday. Do you have any questions you would like answering on Sipps or other pension changes coming into force next April. Please use the form below to send us your questions.
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The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.