What now for Self Invested Personal Pensions?

SIPPs (Self Invested Personal Pensions) have taken a bit of bashing with the shock announcement in the Pre-Budget Report that so called "exotic investments" and residential property will effectively be banned from A Day (6th April 2006).

By axing residential investment, Gordon Brown has put paid to any plans you may have had of transferring existing, or new, buy-to-lets and holiday homes into your SIPP. As for exotic investments, race horses, paintings, antiques, jewellery, yachts, fine wines and vintage cars will now be off the SIPP menu So what is left of SIPPs following this dramatic u-turn?

Well, quite a lot as it happens. SIPPs remain attractive investment vehicles and will benefit from generous contribution limits from 6 April 2006 (A Day). In the 2006-07 tax year, you will still be able to get tax relief on contributions of 100% of your taxable earnings up to £215,000, with unlimited contributions allowed in the year you take your pension.

Permitted investments still include a whole range of assets including direct equities, mutual funds, bonds, gilts, insured funds, OEICs, traded endowments, cash, ground rents, hedge funds, private equity, commercial property and, from A Day, unquoted shares.

Commercial property will still be permitted, albeit with a lower gearing limit post A Day of 50% of your pension fund's net value (compared to 75% of the purchase price as currently applies). Furthermore, the definition of commercial property is reasonably wide and includes hotels and motels, guest houses (including ski chalets), nursing homes and public houses. Some of these properties could also include an element of residential property, providing it is linked to a commercial property, such as a caretaker's flat in a nursing home or a flat above a pub.

Read more about the Chancellor's Pre-Budget Report 2005 decisions.

SIPPs will also continue to be an appropriate vehicle for doing income draw down in retirement, which, post A Day, will be known as taking an Unsecured Pension (UP) up to age 75, or an Alternatively Secured Pension (ASP) after age 75.

Drawdown is the mechanism whereby you can defer buying an annuity by taking 25% tax free cash at retirement and keeping the remainder of your pension fund invested until the time when you choose to buy an annuity or die. Currently, purchasing an annuity must be done by your 75th birthday, but post A Day this rule will effectively be scrapped because you will be allowed to continue doing a restricted form of income drawdown via an ASP after age 75.

Bequeathing your pension fund to your heirs via a family SIPP post A Day will also be possible; providing you haven't purchased an annuity by the time you die. However, your fund is likely to be subject to inheritance tax, details of which are due to announced soon.

The Chancellor also announced in his Pre-Budget Report that the Government would take action to prevent abuse of the rules for tax free lump sums, "where these are recycled back into pension funds in order to generate artificial levels of tax relief."

This is a reference to the facility whereby, post A Day, individuals aged 50 and over could establish an Unsecured Pension each year, make a contribution and immediately take 25% tax free cash, while leaving the rest of the fund intact, (because there will be no obligation to take an income each year when taking an Unsecured Pension). The tax free lump sum could then be re-invested as a new contribution and the whole exercise repeated year after year in order to extract maximum tax relief.

It is this exercise which the Chancellor wants to ban, saying that "the Government will introduce a small package of supplementary measures to ensure the pension tax rules operate as intended." However, many IFAs say that the re-cycling of tax free cash as fresh contributions will be impossible to stop. IFA Donna Bradshaw of IFG Group commented, "If someone has sufficient net relevant earnings to make a pension contribution and get tax relief, then clearly they should be entitled to do so, just as they are allowed to now. How can the HMRC possibly know what the source of the money for the new contribution is? They really haven't thought this through."

Hopefully the boffins at HMRC will clarify matters in due course. In the meantime, the short term effect of the Pre-Budget Report is that pensions cease to be quite so 'sexy'. The long term effect will be that pensions revert to being serious investment vehicles, designed to generate an income in retirement, and perhaps that will be a good thing.

12 December 2005 © Moneyextra.com

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