Sipps: use your pension tax breaks

Squirrel holding a golden acorn © Getty Images
Squirrel it away in a Sipp

It makes sense to exploit your Isa allowance, but don’t neglect your pension. Generous upfront tax relief makes occupational or personal schemes an efficient way to save.

At this time of year the focus is always on Isas. But it’s also important to take advantage of generous tax reliefs on pensions, some of which operate annually, too. Each tax year, pension savers get a new annual allowance. At present, in most cases, this caps your pension contributions (including any made by your employer and the value of tax relief) at £40,000 or the total value of your earnings, if lower.

There are two exceptions to this rule. Firstly, those with earnings of more than £150,000 get a reduced annual allowance, tapered down by £1 for every £2 you earn over this threshold until you reach an income of £210,000; anyone with earnings at this level or above gets an annual allowance of £10,000.  Secondly, very low earners, or those with no income at all, still get an annual allowance of £3,600; they can claim basic-rate tax relief on this allowance, so making full use of it costs only £2,880. Make as much use of your annual allowance as possible. The downside to pension saving for many people is that you have to accept your money will be out of reach for some time to come. Pensions can’t currently be accessed until you reach the age of 55, and this limit is due to increase over time. Against that, however, pension saving is highly tax-efficient.

For starters, you get upfront income-tax relief on pension contributions. So a £10,000 contribution costs basic-, higher- and additional-rate taxpayers only £8,000, £6,000 and £5,500 respectively. Then, inside your pension wrapper, your savings grow completely free of tax. Finally, while income from a pension is taxable (unlike income from an Isa), you can take up to 25% of your fund tax-free.

How your employer can help

Pensions come in different forms. If you have the option of pension-scheme membership at work, you should take it up, since your employer is then legally obliged to top up your savings with contributions of its own. From 6 April, the minimum employer’s pension contribution is 3% of your salary, though many employers pay more.

The alternative, for those who don’t have access to a work-based pension scheme, is an individual arrangement such as a personal or stakeholder pension. These plans are available from companies such as life insurers, fund managers and stockbrokers. You’re entitled to the same tax reliefs as in an occupational pension scheme, and you invest your money in your choice of funds from the provider’s range.

Self-invested personal pensions (Sipps) have become increasingly popular in recent years. Sipps give you more control over the investments you hold in your pension – they’re sometimes described as DIY pensions. They also make it easier to take advantage of the pensions-freedom reforms introduced in 2015, which enable savers to draw an income directly from their pension funds in retirement, rather than having to buy an income with an annuity plan from an insurance company.

A Sipp will typically give you access to all the funds you might consider for your Isa, including unit trusts, investment trusts and exchange-traded funds (ETFs); you can also trade in individual stocks and shares through your Sipp. It is also possible to use Sipps to invest in a broader range of assets, including commercial property, though not all Sipp providers offer such facilities.

However you choose to invest your contributions, maximising pension savings from an early age is crucial. Note that the annual allowance rules aren’t quite as inflexible as the caps on Isas, in that you can carry forward any portion of the allowance you don’t use to the next three tax years. In 2018-19, for example, this could extend your annual allowance to £160,000 if you’d made no pension contributions at all in the previous three years.

The only caveat is that a lifetime allowance also applies on pensions. This limits the total value of pension savings – including all contributions, tax relief and investment growth – you can build up without paying additional tax charges. Currently, the lifetime allowance is £1.03m, with ministers committed to raising it in line with inflation each year.

Our pick of the best Sipps

Best for small and simple

Halifax Share Dealing offers very competitive pricing on smaller Sipp portfolios, with an annual administration charge of 0.18% on pension funds up to £100,000. Halifax offers access to 2,000 funds and a respected stockbroking service should you want to trade individual shares.

Best for large and simple

Interactive Investor charges a flat fee of £100 for its Sipp, rather than a percentage-based levy, so it offers good value on larger funds, particularly those above £250,000. Its investment options are wide-ranging, though dealing fees will soon mount up if you change your holdings regularly.

Best for more complex products

If you want access to the full range of possible Sipp investments, including commercial property, you will need a more specialist provider. Consider AJ Bell: it also scores highly on competitive charges.

Best for drawdown

When it comes to tapping your pension savings (normally you must have reached the age of 55), most Sipp providers impose additional charges. Hargreaves Lansdown doesn’t, so it is a good option for those with funds worth less than £100,000. On larger portfolios, Halifax Share Dealing and Interactive Investor offer better value.