A Self Invested Personal Pension is a type of retirement savings account which is tax-efficient and is available to the people in the United Kingdom. It offers you the freedom to allocation your money in different investments approved by the Her Majesty’s Revenue and Customs (HMRC) which is a non-ministerial department in the UK. It is the government’s responsibility to collect the tax and to pay some form of state support. The approved investments include bonds, stocks, exchange-traded funds and mutual funds. This is different than a company-sponsored pension, where the company shortlists the investment options. The SIPP was first introduced in 1989 and have become quite popular in the United Kingdom because of the end of lifetime careers and final salary pensions.
The Self Invested Personal Pension illustrates a few differences between the retirement plans in the UK vs. The US. In the US, retirement plans tax relief works in two methods. The first way is to invest the pre-tax money, earn growth within the account free of tax, then pay the taxes while withdrawing money, as with the traditional IRA or 401(k). The second way is to invest after-tax money, enjoy growth within the account tax-free, and withdraw funds without having to pay tax, as with a Roth IRA or Roth 401(k).
However, in the UK, the SIPP has a third approach. The taxpayers can claim tax relief on their pension contribution on hundred percent of their earnings, up to £40,000 per year. This tax relief comes in the type of a refund which is contributed towards the pension. For instance, a basic rate taxpayer of 20% who contributes £10,000 to their pension becomes eligible to reclaim up to £2,000 from the HMRC. They can deposit this money into their pension account. But, there is no tax relief on more than £40,000 contributions for pension.
How SIPP works?
This type of investment allows you to save for your investment without having to invest through your workplace. There are commonly four steps for investing in a SIPP:
- Choose the provider you wish to invest with
- Select the funds you can invest in
- Determine the amount you can invest in each fund
- Manage your pension account online
Things to consider when opening a pension account
Fee Management just like with other investment accounts, SIPP fee management is important. You need to see whether the pension account charges an annual fee, trading commission, a percentage of your portfolio value, or other charges before you open a pension account. Remember to select the low-fee choice to avoid harming your long-term investment return. For instance, a fixed annual fee may be cheaper for somebody with a high-value portfolio compared to a yearly fee. You can manage your account online, or you can also hire an investment manager whichever suits you best.
- Withdrawing funds
When you invest in a pension account, you can withdraw money when you reach the age of 55, even if you still work. Usually, you can take 25% of your funds tax-free, but the rest will be taxed as income. Once your money is deposited in a pension account, they grow free of UK capital gains and income tax.
- Tax benefits
Just like other pension accounts, there is no income tax or capital gain tax attached to investments in a pension savings account. Also, you get tax relief on your pension contributions. This means that the funds you would have paid in income tax on pension earnings are paid back by the government into your pension account.
Limits to this tax benefit?
If you are a UK resident, then you can typically contribute all of your earnings or
If you are a resident in the UK then for tax purposes, you can usually contribute 100% of your profits or up to £3,600 if it’s higher, and earn tax relief every year, up to an existing annual allowance of £40,000 for most people.
Unlike an ISA, you can carry forward any unused allowance. As long as your pension contributions add up to no more than 100% of your earnings, you can employ any unused allowance from the previous three tax years if you have been a member of a pension during this period. The annual allowance on SIPP can be tapered for earning of more than £200,000. However, it depends on the level of contributions you make to your pension account, among other things.
Why might you want a pension account?
Whether you need a pension account depends on your circumstances. For instance, you need to consider using up any auto employer scheme matching that is available to you before you invest in self-invested personal pension UK. That’s because you don’t want to miss out on the employer contributions. However, if you work as a contractor or are self-employed and do not have access to any workplace scheme, or if you often change jobs and want a flexible account to consolidate your pension savings, then you might prefer to take out a SIPP.