SIPP. What's the catch?

[LemonCake79]

I've recently been promoted and I'm keen to start thinking about how I can use my pay rise to fund an early retirement. There's no way I can be working as hard as I do at 68.

I'm early 40's and have 8 years left on my mortgage. I will have paid it off by the time I'm 50. DH and I both have good occupational pensions we've been in since we were 22. We can't access them until 65 at the earliest though so I want to start saving for an earlier exit.

We have decent cash savings pots so rainy days are (hopefully) covered.

Given the long term thinking here I was keen on an investment ISA but I've been reading about SIPPs. This seems like the best way forward provided we are certain we won't want the money before we are 57? I feel as though there must be a catch I'm not seeing?

We are both high rate tax payers so I understand we can claim additional tax relief. Does that go into the pension pot or reduce our tax burden? I'm not very good at tax, I only do the return to pay the child benefit back.

Any thoughts gratefully received.

Bear the annual allowance in mind - you can only get tax relief on contributions/pension growth of £40k each year. If your occupational scheme is a defined benefit one, it’s the overall growth in benefits that counts towards the annual allowance, not the value of the contributions you pay in. If your occupational scheme is defined contribution, then it is the value of the contributions paid in that counts towards the annual allowance.

No catch - the inability to access before 57 (and this has gone up - used to be 55 - could it go up again?) could be considered a catch.

The basic tax relief goes into the pension - unsure about higher rate.

Contributions will be added to your occupational scheme - so if these are good and you have been in them a long time you may need to consider the cap.

One thing I would review is your insurance policies - it could be you have these in place already or through your occupational pension - but in the case of critical illness (or terminal illnesses), would you manage with the mortgage payment and your lifestyle or would you be cursing having money tied up in a SIPP?

Thanks @ChessieFL, I wasn't aware of that. I'll need to check the details of our schemes. It's a career average and I must admit I just pay the money each month and don't give it too much thought.

@Schoolchoicesucks, I think I need to know what would happen to the money if I died because the obvious advantage of an investment ISA is the ability to pass it on in our wills. That could be a catch?

Good point re insurance but we are loaded up on that. It was something we really invested in when the DCs were born to ensure we could cover critical illness (them and us) and allow the other to live mortgage free if anything happened to one of us.

I think we are responsible with money hence overpaying the mortgage and getting that right down. I've never dabbled with investments though. It's the realisation I could have to work until 68 if I don't plan properly that has made me focus on the need to invest some of my pay rise.

Is the occupational scheme defined benefit? It sounds as if it is. If paying extra to that an option to consider too? You're likely to be able to access it before 65 but with a reduction in benefits to do so. It might not be the best option for you, even if it is available, but worth making sure that you understand the detail and options within the scheme. Do you mind saying which one it is?

I think I need to know what would happen to the money if I died because the obvious advantage of an investment ISA is the ability to pass it on in our wills. That could be a catch? You can nominate a beneficiary for your SIPP and if you are under 75 they will inherit tax free www.youinvest.co.uk/pensions-and-retirement/accessing-your-pension/sipps-and-death

I'm a civil servant @Mia85, I think I probably can access it early but worried it would erode it too much so I'd been thinking more along the lines of saving to cover five years or so of income which is when I came across the SIPP.

I think I maybe need to look at the work calculator because I guess you are suggesting I might do better to put the money in the occupational scheme.

I'm not sure that would work for DH though, their scheme is definitely less flexible. He works for a large, global company and their scheme is good for private sector.

Thank you so much for your thoughts. This is all really helping me think this through.

And @Mia85, thank you for answering re death benefit.

I would start by discussing your retirement planning with your employer's pension scheme. If it's DB, you may be able to purchase extra years. If it's DC, how much do they contribute, and how are additional contributions handled?

good occupational pensions - can you give more info about that? If you have a Defined Benefit scheme at work (such as NHS, Police, Military, Civil Service, Local Government, Teacher) then you will need to estimate your Pension Input Amount for the coming tax year, so you can work out roughly what could be paid into another pension, without breaching the annual allowance. Have a look at past annual pension statements, look for anything it says about Pension Input Amount, Annual Allowance, Lifetime Allowance.

You need to be aware of Annual Allowance and Lifetime Allowance, though don't let Lifetime Allowance issues stop you paying in to a pension... see this video:

As a higher rate tax payer you would claim additional tax relief on your pension contribution via your tax return. I am not a higher rate tax payer so I'm not sure the mechanics of that but it should not be too difficult.

If you died a SIPP can pass outside of your Estate. That is an advantage over an ISA, which is within your Estate. Don't let that stop you doing both though, having money in different places is good, as it keeps some accessible and some tied up.

This video may help you to understand the differences between your Defined Benefit pension scheme and a Defined Contribution scheme/SIPP:

BR tax relief paid by HMRC into the pension fund. HR tax relief claimed by you against your personal/SA tax.

So if you pay in £2,800, HMRC chip in BR relief of £700 so your pension fund value becomes £3,500. You then claim HR relief on your personal SA tax return which reduces your personal tax by £700 ( or triggers a refund to you of £700 if there's no outstanding tax liability). (Or you can contact HMRC to have the HR tax relief adjusted via your PAYE tax code).

So you end up with a pension fund of £3,500, for which your net cost was £2,100 (i.e. the £2,800 you paid less your tax reduction of £700).

A pretty good deal really.

A person who was a friend-of-a-friend who is an IFA but who wasn't officially "advising" me at the time told me that vast amounts of fees are wasted by people who buy a SIPP and don't understand what they have bought.

If you will be an active investor, keeping track of the value of the investments and juggling funds between different holdings as markets rise and fall, and perhaps also wrapping in other non-stocks-and-shares investments in with your portfolio, then a SIPP is right for you. If you just want to set up something that you will pay money in to each month and will choose one of the menu of managed funds that you trust the investment company to monitor for you, then you are wasting the usually higher fees of a SIPP and there are cheaper investment pension products that you can set up instead.

Are you in Alpha OP? I think I am right in saying that you have the option to either purchase extra annual pension entitlement or contributing to the Civil Service AVC scheme www.civilservicepensionscheme.org.uk/your-pension/managing-your-pension/increase-your-pension/added-pension/

I would consider these as well as a SIPP.

The moneysavingexpert pension forum has some knowledgeable posters and lots of people who have made similar decisions so have a look there too e.g. forums.moneysavingexpert.com/discussion/6143776/civil-service-added-pension-or-sipp

But ultimately make sure you understand your options thoroughly and also how far you currently are from the pension you are aiming for in retirement.

I’m just about to be a higher rate taxpayer and going to salary sacrifice into a SIPP because I will save the NI as well as tax. I also have a DB scheme but like you would ideally like to have something to allow me to go part time etc from 57 or whatever the minimum age is by then.
Personally I would also invest in an ISA if you can afford to do that you have some shorter term cash that way if you want it in advance of your SIPP maturing.
Stocks worldwide are low at the moment (could well go much lower) so a good time to start investing - index funds are worth a look.

Thanks @Mia85, yes, I'm in Alpha. Was in Premium before the changes.

Those links are really helpful, thank you.

@TiddleTaddleTat, my original plan was an investment fund, probably an ISA on the basis that prices are low and I have about 20 years for it to grow. Was attracted by the tax relief on a pension though... I could spread the money across both I guess.

Just on your pension scheme age. I think you need to look at this carefully and make sure you really understand you it applies to different parts of your pension. I don't know the precise answers (perhaps some people on here do know) but if I were you I would be looking at:

1. If you were in Premium before that chunk of your pension would have been built up with an earlier retirement age, presumably 60. Presumably this chunk can be taken at that age without any reduction for early payment.

1. How does the McCloud judgment apply to you? It sounds likely (depending on your details) that your later contributions will also be treated as if built up in Premium.

Find out exactly how the pension age will work for you because you might find that you are already far further along the road to retiring earlier than 68 than you thought because a large chunk of your pension won't be reduced if taken early.

Disclaimer I am not an IFA and am only raising the Qs!

Thank you, I am impacted by McCloud, I understand I can choose later in life whether you preserve premium until 2022. I need to get my head into it all, I'm guilty of just paying the money each month and not thinking about it all. Will do some more research.

Hopefully you are right and it's not as bleak as 68.... 🤞

Yes hopefully! I'm not saying that you shouldn't open a SIPP just that you should make sure you have a really clear picture of your current position so that you can decide what your goals are.
It sounds as if you are well paid and have been in the scheme for a long time. Make sure that you are also aware of your lifetime allowance. The calculation for defined benefit schemes against the lifetime allowance is very generous but the allowance has been frozen for years and if you are likely to be close to it that might be a reason for preferring ISA to pension

You have to pay tax on the money in a SIPP when you take it out - does that count as a catch? You get 25% tax free, but after that it counts as income to be taxed. You still get a personal allowance when you retire so if it’s your only income you won’t have to pay tax on the first £12k or so.

I have teachers pension from 60 but have also paid for 17 years into a stakeholder which is like a SIPP. Like you I knew I would need to retire early. I took early retirement at 57 so had 3 years until I could claim TP but 10 years until state pension kicked in. I decided to drawdown my stakeholder over 7 years from when 60 until 67. The investment left undrawn each year continues to grow. If you are higher rate taxpayer you could pay anything over limit for paying 40 percent into a SIPP and you will get government top up. You would pay it in tax anyway so may as well put it into a pension fund. Money from SIPP you can drawdown after you are 57 or take as annuity if you prefer to guarantee income up to pension age. You can do annuity over 7 years only. You don't have to stretch it out over lifetime. Anything left in a SIPP at time of your death if under 75 just gets added to your estate. I also bought 7 btl properties and take a small income from those but they are also going up in value sharply, so will be good to leave to kids. I also overpaid my mortgage and only have less than 2 years left now. If you have kids you could also gift them up to £3k a year and invest for them. This will lower inheritance tax later on when you die.

@Hazelnut5

You have to pay tax on the money in a SIPP when you take it out - does that count as a catch? You get 25% tax free, but after that it counts as income to be taxed. You still get a personal allowance when you retire so if it’s your only income you won’t have to pay tax on the first £12k or so.

If you're a higher rate taxpayer, then you get 40% tax relief (or more), but probably only pay 20% basic rate when you take it out again as pension as very few people will have incomes of over £50k once they retire, certainly far fewer than those with incomes over £50k whilst in employment.

Thanks again @Mia85, going to sit down and get my head around what I've already got.

Good point @Hazelnut5.

@caringcarer, thank you for sharing your story. I'd hate to give the impression I don't enjoy my work because I do but it's intense and the workload can be insane. I just can't imagine working like this at 68! Really interesting to hear it all worked out as you planned. Can I ask how old you were when you started to focus on retiring early?

@LemonCake79, I started Stakeholder when I was 40. Did not really think of retiring early then but wanted to keep options open for future. I was about 52/3 when I went through menopause as all my energy literally went. I was constantly tired, brain fog (not good for teaching GCSE and A level groups), periods flooding, hot flushes. At 55/6 I woke up one day and thought I don't need to do this. My older sister retired from teaching and I thought I will work out year then I will retire. My replacement cancelled at last minute so Head asked me if I would work another term so I agreed. 57 and 4 months when Ieft. I loved teaching but never regretted leaving. I did some tutoring for 2 more years but actually found plenty to do each day. Went to gym, lunch out, took up crochet, pottered in garden, word puzzles, read books, took on running of btl houses and renovated our French house. Relied upon Btl income until 60, then got lump sum, bought another btl in property, now get TP. My dh still works as he loves his job and he is a few years younger than me but he plans to drop down to 3 days a week in 2 years when he is 60. He will get lump sum then and can draw some civil service pension but rest is in different scheme was and he can't get until he is 67. Then state pension too. Reason I opened Stakeholder originally was on divorce from first husband I got lump sum from his pension to balance out. I had to open stakeholder. Best thing I ever did.

Thanks @caringcarer, that's really interesting and shows I'm a good age for planning this.

I want to end my career the same way, having loved it and not completely exhausted by it and hating it.

@Hazelnut5

You have to pay tax on the money in a SIPP when you take it out - does that count as a catch? You get 25% tax free, but after that it counts as income to be taxed. You still get a personal allowance when you retire so if it’s your only income you won’t have to pay tax on the first £12k or so.

You can drawdown a lump sum tax free when you reach 55/57 Or If you do not drawdown a lump sum you can choose to have 25% of every drawdown tax free forever. Someone will correct me if I'm wrong.