UK pension schemes have not historically done as well at the Government would like to see, especially in the area of being attractive enough to encourage workers to save for retirement. This is the main impetus for the rule changes that were introduced with the 2014 budget. With the announcement of the rule changes, one of the hottest topics right now is transferring a workplace pension to a self-employed personal pension (SIPP).
The Government hopes that changing the rules encourages more saving through a combination of auto enrolment, greater pension flexibility, and more options for dealing with stranded pension pots. Where those smaller pots are concerned, a SIPP can be a good option for taking under-performing pots and creating a larger, better performing pot. However, transferring a workplace pension to a SIPP is not the right option for everyone. There are many things to consider.
Reasons for Transferring to a SIPP
A consumer unhappy with the current state of his or her pension funds may hear an advert for a SIPP and assume transferring to a new scheme will be a better deal. Why? There are a number of reasons people transfer, including:
- the opportunity for a cheaper scheme
- greater control over investment choices
- a desire to consolidate multiple small pots.
The SIPP offers a vehicle that can help accomplish these goals. For example, the typical SIPP is set up and administered by a bank or insurance company. They may have lower charges than the pension provider currently controlling the investment funds. As for greater control, this is one of the most attractive features of the SIPP.
A SIPP investor can choose a scheme known as ‘execution only’. This type of scheme utilises a pension administrator solely for the purposes of executing transactions on behalf of the investor. The pension administrator makes no choices about how funds are used. The investor retains full control over his or her account, win or lose.
Investors can also choose a SIPP scheme that is fully advised by the pension administrator. In such a case, decisions are still left to the investor, but research and advice is provided by the pension administrator before any decisions are made. This provides the investor the control he or she desires without the potential risks of remaining completely independent.
Caution Is Advised
We cannot overstate the fact that exercising caution with SIPP pensions is absolutely necessary. There are too many potential pitfalls to rush headlong into a pension transfer decision without learning as much as possible beforehand. Keep in mind that there are plenty of companies offering cheap SIPP DIY pension schemes that turn out to not be genuinely interested in the well-being of customers.
Consumers should be aware that there might be certain penalties, charges, and other downsides that would make transferring a workplace pension to a SIPP unattractive. Among them are the following:
- Exit Penalties – Pension administrators typically apply charges when the consumer wants to exit. These charges, ostensibly applied to cover the costs of the administrator, can end up being several thousand pounds. They may be high enough to make the transfer of a smaller pot financially detrimental.
- Bonuses – If your current pension administrator offers bonuses for staying with them, those bonuses will be lost upon transfer. The pension administrator may also withdraw any bonus money already paid.
- Guaranteed Annuity Rates – Investors planning to use pension funds to purchase an annuity at retirement need to know whether their current workplace pensions offer guaranteed annuity rates (GARs). Any GAR offered will be lost through pension transfer to a SIPP.
- Employer Contributions – Transferring a defined contribution pension from your current employer to a SIPP will result in the loss of those contributions. It is advisable only to transfer stranded pots to a SIPP account.
It is important for the investor to understand the differences between the defined benefit and defined contribution pension prior to transferring to a SIPP. Most investors with a productive defined contribution pension will see no benefit from transferring to a SIPP at this time. If the investor is looking for greater control and greater returns, a better option is to set up a separate SIPP that can be invested in using money that might otherwise be put into savings.
Maximising State Pensions
A consumer planning to combine multiple stranded pension pots with a state pension at retirement may want to consider transferring the smaller pots to a SIPP right away. A well-planned and executed SIPP pension could provide higher returns than are currently being realised. Rule changes with state pensions are a big factor to consider now.
Maximising returns from state pensions is about getting the most from all of your pension funds, regardless of their source. Nevertheless, understand that rule changes indicate you now may get less from your state pensions than you previously expected. If so, you are a good candidate to either transfer smaller, stranded pots into a SIPP or open a new SIPP from scratch. The money you earn from a SIPP pension can boost smaller state pension payouts when you retire.
A SIPP pension is a good option for investors with multiple, smaller pension pots that have been stranded due to a change in employment. Combining them into a single self-invested plan gives the investor greater control over the future of his or her money. Furthermore, combining multiple pots into a single SIPP gives the individual more investing power by which to generate greater returns.
As always, do not make a decision to transfer into a SIPP pension without first seeking the advice of your current pension administrator, a financial planner, or a certified financial advisor. Pension rules are too complex to attempt to navigate them on your own. Sound advice from professionals can help you understand all of your options along with the risks and benefits of each one. Seeking advice is the best way to make sure any decision you reach is a wise one.