Last time in Magical Penny’s pension series we discussed the 3 Reasons to Open a Self Invested Personal Pension .
To recap the reasons to have a SIPP were:
- Tax efficient saving
- More choice
- More control
However, as a mid-20 something I don’t have a SIPP and I don’t think you should have one too. Whilst SIPPS have many advantages, for most people in their 20s and 30s its not the best way to save.
SIPPs don’t give you extra money like an Employer pension can
For many of us, the first time we think about pensions is when we are offered one at work. If your employer offers to contribute to a pension, you should definitely take it because it is ‘extra’ money on top of your salary -the only difference between a pension contribution and a raise is that you can’t access the pension money until you are 55+. But it’s still yours no matter what. It’s not tied to your company (unless you have what’s called a ‘vesting’ period, or it’s in the form of company stock but that’s a whole other article).
Bottom line: Pensions offered through employers typically aren’t as SIPPs in terms of cost and performance because they often have limited investment choices and costly funds, so you may be tempted to get a SIPP. But your first priority should be an employer based pension for the sole reason of the company ‘match’ -free money that you would leave on the table if you decided against it.
You can’t transfer a current pension into a SIPP
Another reason SIPPS aren’t a good option for young people is that you can’t transfer a current pension into a SIPP. For many of us, we are already paying into a pension with our employer so whilst a SIPP would be better (for more control and choice), we can’t really take advantage of a SIPP because we can’t transfer the pension we already have if our employer is still paying into the current plan.
Bottom line: Make sure you are maximising enough in your employer pension before you even think about a SIPP.
One way to get around this would be to get your employer to agree to pay into a SIPP rather than an employer based plan but in my experience it is relatively rare that employers agree to this.
You can’t transfer an old pension into a SIPP if it is less than £10000
If you move jobs it’s likely you will end up with lots of different pension plans. This can be an administrative pain and also make it harder for you to get a full view of your investment allocation and total saving. Therefore, it makes a lot of sense to consolidate your pensions in to one provider. If you can do so, then transferring all your pensions into a SIPP would be perfect as you could have full control of all your investments and have your pension ‘pot’ all under one roof for you to manage effectively. This is what I looked to do when I recently moved companies and wanted to bring my two employer pensions together. However, there are restrictions on the amount you can transfer: to transfer pensions into a SIPP the value must be £10000 (or you must have the cash to top up the value of your pensions to £10000).
Whilst I’m relatively proud of what I’ve managed to accumulate in the short few years I have been working, I’ve not yet reached the heady heights of £10000 in my pension, so transferring my pensions into a SIPP is not possible at this time. Eventually I intend to do this, but until then I will have to wait. I imagine most of us in our 20s are in the same situation of pension pots under £10k. And if you do have more than £10k in your pension I could do with some Magical advice!!
Bottom line: opening a SIPP now would not make any sense because it would not help me or you reach the£10000 transfer goal to get all the various pension pots in one place. Concentrate on saving another way first.
SIPPs force you to commit to £300+ a month, or you have to start with a £10k lump sum
SIPPs are great for their flexibility and potential for low-cost tax-efficient investing, but because they can be so inexpensive (and therefore not big profit centres for investment houses!) many providers have rules about minimum investment levels. Typically you have to commit to pay in £300+ a month into a SIPP when you first take it out, or you have to start with £10000 as a lump sum. Personally I don’t think this is realistic for those of us in your 20s at the start of our careers. Whilst saving money for retirement is important, there are many other things to save for and being forced to save at least £300 could lead to stress and strained financial priorities.
Bottom line: SIPPs can be so awesomely cheap for investors that investment companies want to make sure their admin costs are covered by insisting on high monthly contributions. It’s just not practical for most 20 somethings so don’t rush into a SIPP because you’ve heard it’s tax efficient.
If you are not a higher-rate tax rate a Stocks and Shares ISA would be better
The benefit of a SIPP is your money gets to grow tax free -but you get a similar benefit in a Stocks and Shares ISA. The difference is that a pension saves you money at the start and the ISA saves you money at the end (you are not taxed when you take money out whereas with a pension you are)
If you are a higher rate tax payer (earning around £40k or more) then a SIPP is amazing as it allows you to skip paying 40% tax on your earnings above the higher rate threshold, essentially meaning you get £100 in your pension for only £60. This compares to the benefit of a standard rate tax payer who only gets to ‘save’ 20% -£100 in a pension for a real cost of £80.
Most of us in our 20s are standard rate tax payers so the benefits of a SIPP are not as good for us -but we can do something clever about it. We can save money in a Stocks and Shares ISA (which by the way can be just as flexible as a SIPP) and let it grow tax-free. Then, once we are earning at the higher tax rate, we can redirect the money into a SIPP or other pension -essentially getting the 40% tax relief on the whole sum of our savings!!! That’s huge! For every £600 we save, we can eventually turn it into £1000 of pension money (assuming we are earning at a higher-tax rate).
It’s a little complicated to explain but once you understand the concept, it lessens the appeal of a SIPP if you are a standard rate tax payer….as long as you commit to investing in a Stocks and Shares ISA instead.
BOTTOM LINE: A Stocks and Shares ISA is just as good as SIPP, only you save post tax rather than pre-tax. In fact, it can be more flexible than a pension as you can access it any time you need, and you can search out the inexpensive investment funds in the exact same way as for a SIPP.
And if you get your head around the tax game, it can make a lot of sense to first save in an ISA when you tax band is low and then move it to a SIPP when your tax band is high.
In summary, I’m looking forward to opening a SIPP when the time is right, but it’s not the right time for me at this stage, and if you are in your 20s it’s unlikely the right time for you. But don’t let that stop you from saving and investing in other ways:
- Getting rid of all debt apart from ‘student loan company’ debt
- Joining an employer pension scheme for the ‘match’/free money
- Investing as much as you can in a Stocks and Shares ISA -up to £10k+ a year currently
- Opening a SIPP when you’re ready (reaching higher rate of tax or have £10k pension pot already)
I hope you found this helpful -if you have any questions I’d love to clarify things through email: adam AT magicalpenny.com