What is a SIPP and how can compounding increase returns?

What is a SIPP?

SIPP’s (Self Invested Personal Pension Plan) are a UK government approved pension scheme which offer a fantastic way to help save for retirement. Anybody aged 18 or over who is a resident of the UK can open a SIPP. What differentiates SIPPs from salary sacrifice workplace pensions is that they offer more flexibility because individuals have the ability to invest in a wider range of investments

Why invest in a SIPP?

• Anybody under 75 years of age can claim tax relief on a SIPP. If you pay into a SIPP you will receive a 20% top up from the government. For example, if you want to make a total contribution of £3,125 into your SIPP you would need to deposit £2500. If you are in the higher or additional tax rate you will not be at a disadvantage, you will still receive tax relief up to £40,000. This is the maximum amount one can pay into pension schemes and claim tax relief on each year. With Options UK the basic tax rate will be claimed by us, however, if you’re in the higher or additional tax rate you will need to claim the remaining the extra tax relief.
• SIPP’s offer flexibility in terms of what you can invest in, with IG you have the option to invest in shares, funds and investment trusts in a SIPP. However, with company pensions you often have limited selection choice because the pension provider usually invests in a selection of funds based on one’s risk tolerance.
• From the age of 55 anybody can access 25% of the value of their pension fund, this can be taken as a tax-free lump sum. You can also take regular income payments by purchasing an annuity or access your SIPP via income drawdown. If you want to withdraw more than 25% of the value of your pension fund before the age of 55 you will be charged a tax rate of approximately 55%.
• SIPPs are a great addition to the state pension which is currently £9,627.80 per annum. The state pension age is currently 65 for both men and women, this is increasing to 67 by the year 2028. SIPPs provide a great supplement to the state pension, which arguably is not enough to live on. Many pensioners may require an additional source of income to enjoy their dream retirement. To open a SIPP you need to deposit £1,000 a month or make a lump sum payment of £10,000. Alternatively, you can transfer your SIPP from any UK registered or recognised overseas pension scheme.
  

What is compounding?

Compounding increases the value of your asset at a rapid rate because you earn interest on your returns, however, with simple interest you don’t earn money on any of your returns.

Figure 1 highlights the compounded returns if you invested £10,000 in a SIPP and deposited £500 a month for 20 years assuming a 5% annual growth rate. Across the 20 years you would have deposited (£10,000 * 1) + (£500 * 12 * 20) = £130,000. However, after these 20 years the total value of your SIPP portfolio would be £232,643.24. This represents a return on investment which equates to £102,643.24.

Figure 1: The effect of compounding returns

With compounding the value of your investments is not always guaranteed to appreciate, all investments are subject to risk.

How does age impact asset allocation?

When saving for retirement the younger you are the more exposure your portfolio should have to equities, however, this does depend on a client’s attitude to risk. This is because long-term risk reward returns from equities are typically higher than defensive asset classes, such as bonds. Those younger investors can take on more risk because there is more time to recover any potential losses. For example, since 2000 total returns on the S & P 500 has been 330%. Total returns on the Bloomberg aggregate bond index since 2000 have been 111%, significantly less. When close to retirement one may want to reduce exposure to equity, however, when making income drawdown arrangements you still need a return to keep pace with withdrawals.

Who administers our SIPP’s?

We have partnered with Options UK who are an independent pension administration and trustee company who have provided specialist pension services to the UK market for the past 20 years. They are currently entrusted with administering over £1.7 billion of client’s funds across both personal and corporate pensions. Options UK are part of STM Group Plc who are listed on the alternative investment market.

What if I do not want to choose my own investments?

You can also open a Smart Portfolio SIPP where your funds will be actively managed and built exclusively with Blackrock’s iShares ETF’s. The portfolio includes ETF’s which cover a range of geographies and asset classes which include bonds, equities and alternatives assets, such as property and gold. The Smart Portfolios caters to five distinct risk profiles which range from conservative to aggressive. Those higher risk profiles are more weighted towards equities and less towards bonds.