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How do SIPPs work?

Pensions can be a highly effective way to make investments for retirement, due to the generous tax relief on contributions - find out how a SIPP (Self-Invested Personal Pension) works.

| 9 min read

A SIPP stands for Self-Invested Personal Pension and works in a similar way to a standard personal pension, allowing you to save, invest and build up a pot of money. However, SIPPs typically give you a much wider choice of investments, which means you can invest in the way that suits you while harnessing valuable tax relief on the money you pay in.

Tax relief is a hidden investment superpower. It can mean, for instance, that the cost of a £1,000 pension contribution is as little as £550. The government tops up whatever you contribute with 20% basic rate tax relief, while higher-rate and additional-rate taxpayers may claim up to a further 20% and 25% respectively.

How a Self-Invested Personal Pension (SIPP) works

1. Holds a wide range of investments

Most pensions only have a narrow range of investment options, which may be fine for less hands on investors. However, if you are looking to maximise the range of possible investments a SIPP may be worth considering.

The Charles Stanley Direct SIPP gives you freedom and control over the investment decisions made, and you can access an extensive range of investments including:

  • Thousands of funds, investment trusts and exchange traded funds (ETFs)
  • UK and overseas shares
  • Bonds and gilts

This flexibility allows considerable opportunities, but you need to take responsibility for your investment choices, or you can work with one of our Financial Professionals to manage your investments for you. There are also simple solutions for first timers such as our multi asset funds. Each is a professionally-managed portfolio in a single product. Our experts decide on an appropriate mix to balance risk and reward, adapting to changing conditions and trends. Investors do, however, need to be careful in selecting the fund(s) appropriate for their needs.

2. Makes use of annual tax allowances

Your total pension contributions, including those paid by your employer, are subject to an ‘annual allowance’, which is £60,000 in the current (2024/25) tax year. You are also restricted to paying in no more than 100% of your relevant UK earnings – essentially earned income rather than any other form of income such as dividends or interest.

Very high earners get a lower annual allowance, which could limit their maximum contribution to as little as £10,000 a year.. The rules on when this ‘tapered’ annual allowance kicks in are complicated. Very broadly, it could affect people with income and benefits of more than £200,000 a year, but HMRC has more information on how to calculate it here.

For people who receive ‘flexible’ retirement benefits, such as pension drawdown or taking more than 25% cash from their personal pension, a lower annual allowance of £10,000 applies.

If you haven’t used your full annual allowance from up to three previous years, you might be able to carry it forward and use it in the current tax year provided your earnings are high enough and you have been a member of a registered pension scheme in those preceding years. Additional guidance and examples can be found on the government’s Money Helper website.

Remember, the tax treatment of pensions depends on individual circumstances and is subject to change in future.

3. Most UK residents are eligible for a SIPP

You are eligible to open a SIPP account as long as you are a UK resident under the age of 75. Many people ask how many SIPPs they can have, and the answer to this is there is no limit; you may contribute to as many pensions as you like simultaneously but please be aware of the pension allowances described above.

You can pay money in when it suits you, either through lump sums or monthly via direct debit. It is also possible to arrange for your employer to make contributions to your SIPP if they offer that flexibility.

If you are currently contributing to a Workplace pension your employer will be contributing too. You should prioritise this form of pension saving to take full advantage, but you could consider a SIPP for extra pension provision.

4. Flexible pension withdrawals

Unlike ISAs, personal pensions including SIPPs don’t allow you access to your money until retirement age, which at the earliest is 55. This is set to rise to 57 in the future, and the rules can always change. You then have a number of options. Lump sums or a series of lump sums can be taken at any time, with the first 25% usually able to be taken tax free and the remainder taxable under current rules.

Alternatively, you can use the pot to buy an annuity, a product that provides a guaranteed income, also taxable, for the rest of your life. This can be attractive for those who require a secure income and do not wish to take investment risk with some or all their pension.

Annuities can also be tailored to particular circumstances, such as providing a spouse’s pension on death and there are special, higher rates for smokers or those with health conditions. When buying an annuity with your pot it pays to shop around.

5. Credits tax relief based on your contributions

For the Charles Stanley Direct SIPP, basic rate tax relief is credited within 6 to 10 weeks from your personal contribution being received. The tax relief will be applied as cash to your account as soon as it has been received from HMRC. . You must claim higher and additional rate tax relief for yourself via your tax return or by contacting HMRC. Tax relief will not be claimed or applied for gross employer contributions to your SIPP.

6. Can hold existing savings when you transfer pensions

Over the years you may have collected a variety of pension schemes, especially if you have had several jobs. For those who dislike the clutter of a mixture of pensions, consolidating many types of pension schemes into one modern pension can be a relatively straightforward exercise.

A ‘defined contribution’ scheme, such as a personal pension, can usually be moved to another, similar scheme easily, making tidying up these pensions simple. You can typically transfer Personal Pensions, Stakeholder Pensions, Retirement Annuity Contracts (s226), Free Standing AVC's (FSAVCs), Executive Pension Plans (EPPs), and many Occupational Money Purchase Pension Plans. However, you should always check for any exit penalties when considering a transfer.

There can be more significant pitfalls too. If your pension has 'Safeguarded Benefits,' which includes Final Salary or Defined Benefit pension benefits, Guaranteed Annuity Rates and Guaranteed Minimum Pensions, you cannot transfer without a positive recommendation from a regulated advisor. Schemes with these features require regulated advice before transferring and are almost always best left untouched.

Tips for your tax-free pension allowances

  • Employer contributions – always prioritise your Workplace Pension to ensure you benefit as far as possible from money your employer puts it. This will give your pension savings a huge boost.
    • Plan contributions to maximise tax relief – contributing to pensions has the effect of reducing your overall income, and therefore tax burden. Taking note of income tax thresholds and allowances for benefits such as Child Tax Credit is a smart way to ensure your finances are as efficient as possible.
    • Be aware of how much you have to use – The increase to the pension annual allowance from the 2023/24 tax year has created more opportunities to build pension pots.
    • Don’t be too cautious if you are far from retirement – generally, investing mostly in the stock market is the best way to maximise long term returns, even more so if you are regularly topping up your investments to benefit from pound cost averaging. A SIPP offers the freedom to invest in markets and industries you want to target, while potentially enjoying returns as your investments grow – but these are only suitable if you are prepared to ride out the ups and downs that investing entails.
    • Don’t be too aggressive if you are approaching taking pension benefits – if you are looking to consolidate and preserve wealth, and especially if you are looking to take lump sums and/or buy an annuity with your pot in the shorter term (generally considered less than five years), then you should usually take a lower risk approach to reduce the extent of the ups and downs in the value of your pot.

    How to set up a SIPP pension with Charles Stanley Direct

    It’s simple to open a SIPP. Register your email address, provide us with some details, choose SIPP as your account type and follow the instructions to deposit money in your account or start a direct debit. You’ll then need to choose your investments.

    Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

    How do SIPPs work?

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    Charles Stanley is not a tax adviser.

    Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus.

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