3 Reasons to Open a Self Invested Personal Pension

by Adam on February 14, 2013

Pensions need a positive PR campaign. They are often misunderstood and subsequently ignored by many. You definitely should be saving for the long term whatever your age but navigating the dizzying array of options out there can be difficult. In this article I’m going to explain why pensions are good but if you’re in your 20s, other ‘saving vehicles’ may be better.

Firstly, a pension is just one way to invest for your future. Other options are investing in ISAs, or trying your hand at trading. For example, anyoption is a leader in the field of binary option trading. anyoption offers several online trading tools you can invest in.

But when it comes to investing for your long term future, a pension can be a great way to do it:

Pensions in Brief

A pension is simply another word for a ‘retirement’ account.

Pensions allow you to save for retirement quicker than any other way because your contributions are boosted by tax-relief. Here’s how it works. Say you earn £100. As with all earnings you need to pay tax on them so after tax you would be left with around £80 assuming you are a basic rate tax payer (most of us in our 20s are!). Put that £80 into a pension though and quicker than you can say “Magical Penny” that £80 will become £100 again -you’ve got your tax back.

In this regard pensions are great -because you can build up a lot of money in a short period of time. But there are catches. The biggest one is that you can’t access your pension until you are 55 or older. And you can only receive 25% of your pension value in tax-free cash when you convert your pension fund into an annuity by the time you’re 75 -something that turns lump sums into guarateed taxable income for life.

Note: if you are in America and have a  retirement 401k you can access your retirement money early, but it comes at a huge cost: you lose all tax relief AND have to to pay a 10% penelty if you access the money.

Despite the restrictions, pensions are great because they allow you to, at least in part, avoid paying any tax. Which means more money in your pocket. But it’s not as simple as that:

Pensions can be difficult to understand

Firstly its important to understand that a pension is not an investment in itself. Like ISAs, pensions are just like money envelopes that legally hide your money away from tax. But it’s up to you to decide what goes into your pension ‘envelope’. Many pension companies try to simplify the options when they present their ‘investment funds’ and assess your ‘risk profile’  but this very process often makes it difficult to determine what the money in a pension is being invested in. Certainly if you ask the average person what their pension is invested in, they would not know.

Even I didn’t know what my former employer pensions are made up of, despite trying to find more information about it!

 

Enter the SIPP

A SIPP, or ‘Self Invested Personal Pension’ is, in my view, the best kind of pension because as the name suggests, you have full control over what you put in your pension. You can use online platforms to find the cheapest funds, and it doesn’t take much effort at all to put together a bespoke set of investments that are low cost and suit your needs, rather than investing in a generic fund that can be bloated with fees and associated costs.

 

3 Reasons to Open A SIPP

Tax Efficient Saving

Like all pensions the biggest benefit is protection from tax  -the money you would normally have paid in tax out of your earnings is directed straight into your pension. And the more money that gets into your pension, the more it will hopefully grow over time.

More Choice

Many workplace-based pensions are limited to certain ‘fund families’ or investment companies meaning your investment options are limited. But with a SIPP you can invest in almost anything, and find the lowest cost investments. One thing to caution though is not to chase returns. Most of the time the highest performing investments one year become the worst performing investments the next year. By using the benefit of choice, you can better control your investment costs -the only certainty when it comes to investing. Generally, the lower the investment cost the higher the ‘risk-adjusted’ return…i.e. higher performance for the amount of risk you are taking on.

More Control

Most pensions don’t give you much control. For example my employer pension doesn’t have online access, and if I want to change the investments in my pension I have to contact a financial advisor. Meanwhile with a SIPP I could choose an investment provider that gives me online access and be able to monitor and change my investments as I see fit. Whilst investments are best left alone (because more trading increases costs which eat into returns) it still is good to monitor your investments to make sure your portfolio is not lagging the market by a significant margin. With a SIPP you are not a hostage of circumstance and have much more control.

 

Despite the advantages of a SIPP, they are not for everyone – if you have not used your Stocks and Shares ISA allowance then start there, as SIPPs can be slightly more of a hassle to manage.

 

Read more about pensions here: http://magicalpenny.com/tag/pensions/

 

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