You may have found yourself asking, ‘How do SIPPs work?’ while you’ve been doing your retirement planning. 

Here’s another question:

Did you know that, according to recent research used in the Pensions and Lifetime Savings Association’s Retirement Living Standards project, you and your partner could need a pension income of up to £55,000 a year to live comfortably?¹

That may seem like a frightening figure, but if you plan carefully, the flexibility and control you’d have over your investments in a Self-Invested Personal Pension (SIPP) could help you attain your retirement goals.

Our EveryInvestor team has thoroughly researched the world of self-invested personal pensions and has compiled this article to help you make sense of your options when you’re trying to make well-informed financial decisions about your retirement planning. 

All our content undergoes strict quality and compliance checks before it’s published, and we conduct regular reviews to ensure everything remains up to date.

So, whether you are an experienced investor or just starting to explore your retirement savings options, read on…

What’s a SIPP?

SIPP allows investors to make investment decisions based on personal preferences, offering flexibility in choosing from a variety of investment options, such as stocks, bonds, and mutual funds.

Learn More: What Exactly is a SIPP?

How does a SIPP work?

A SIPP, or self-invested personal pension, is a type of pension plan that gives individuals more control over how their pension funds are invested.

With a SIPP, individuals can choose from a wide range of investment options, including stocks, bonds, and property.

They can also decide how much to contribute to their SIPP each year, up to certain limits set by the government.

Contributions to a SIPP are typically made from pre-tax income, meaning that individuals receive tax relief on their contributions.

This allows their pension fund to grow more quickly over time.

Overall, a SIPP offers individuals greater flexibility and control over their retirement savings compared to traditional pension plans.

In summary, a SIPP is a pension plan that allows individuals to have more control over their investment choices.

They can choose from a wide range of investment options and decide how much to contribute each year.

Contributions are made from pre-tax income, providing tax relief and allowing the pension fund to grow more quickly.

This flexibility and control make a SIPP an attractive option for individuals who want to take an active role in managing their retirement savings.

What are the Key Features of SIPPs?

Besides giving you control over your investments, SIPPs have other features as well.

The key features of a SIPP include: 

• It offers tax relief on contributions.
• It offers flexibility around how and when you can draw your benefits.
• It allows you to consolidate all your pension pots.
• It lets you pass on any remaining funds to your heirs.

Keep in mind that there are also certain risks associated with SIPPs, such as the risk of investment losses and the impact of market fluctuations, and that managing these risks will be the individual investor’s responsibility.

Eligibility

Any UK resident under 75 can contribute to a SIPP, whether they’re employed or not.²

Non-residents may also be able to open a SIPP if they’d like to transfer a UK pension into it.³ 

SIPPs work in a similar way to other pension products in the sense that they allow you to make regular contributions or larger payments when you’re able to.

Like other pensions, SIPPs let you save for retirement, but SIPPs offer a much larger variety of investments you could choose to put your money into.

Some of these investment options may include:

• Stocks and shares
• Exchange Traded Funds (ETFs)
• Investment trusts
• Unit trusts
• Open-Ended Investment Companies (OEICs)
• Gilts and corporate bonds
• Real Estate Investment Trusts (REITs)
• Commercial property
• Cash
• Commodities
• Structured products
• Hedge funds

What’s more, SIPPs also offer tax benefits to savers, as mentioned above.

Important

Diversification is key to managing investment risk and not all investment types may be suitable for everyone, so speak to your financial advisor to determine how much risk you should take. 

To take advantage of the benefits of a SIPP, you’ll have to learn how to set up, manage, and withdraw from your SIPP.

How Do You Set Up a SIPP?

Setting up a SIPP typically involves filling in an application form with a SIPP provider. 

Before you get to that stage, however, it’s important to consider factors such as fees, services, and investment options when choosing a provider.

Choosing a SIPP Provider

Choosing a SIPP provider will usually follow after considering several factors, such as the range of investment options offered, the provider’s reputation and financial stability, its level of customer service, and the charges associated with a particular provider’s SIPP.

Opening a SIPP Account

Opening a SIPP account may involve completing an online application. 

You may need to provide personal information, details about your employment and income, your National Insurance number, and your bank details. 

You will also need to decide whether to fund your SIPP by transferring an existing pension into it or by doing a bank transfer or debit card payment to obtain started.

Transferring Existing Pensions to a SIPP

While most pensions can be transferred to a SIPP, you may lose benefits or incur early-exit fees, so make sure you understand the implications. 

For transfers of defined benefit pensions worth £30,000+, professional advice is legally required.⁴

Doing a Bank Payment to Open a SIPP

You could also transfer money from your bank account or make a debit card payment to open a SIPP. 

How Do You Manage Your SIPP?

Managing your SIPP involves making investment decisions, monitoring your investments, and adjusting your strategy as you approach retirement.

Making Contributions

You can make regular contributions or once-off payments to fund your SIPP. 

You can set up your regular contributions as monthly, quarterly, or annual payments, through direct debit, standing order, or payroll deduction. 

Your employer may also contribute to your SIPP if they choose.

There’s also the option of transferring any other pension schemes you hold into your SIPP, including workplace pensions or other personal pensions.⁵

Annual Allowance Considerations

When contributing to a SIPP, most people are able to save up to £60,000 per year and benefit from tax relief on their contributions.

You could keep contributing once you’ve hit this annual allowance, but any amount that exceeds the limit won’t be eligible for government tax relief.⁶ 

Lifetime Allowance Considerations

In April 2023, the government made changes to the lifetime allowance for pensions by abolishing the £1,073,100 limit.⁷

Previously, accumulating pensions savings beyond this threshold over your career would trigger a tax charge on the excess amount.⁸ 

Investment Decisions & Strategies

It’s important to review your investment decisions and strategies regularly to make sure they remain aligned with your retirement goals.

Speak to a qualified financial or pensions advisor to discuss how best to diversify your SIPP.

Monitoring & Reviewing Your SIPP

Monitoring and reviewing your SIPP’s investment performance over time allows you to assess your risk level, and consider whether any changes are needed.

Adjusting Your SIPP as You Approach Retirement

As you approach retirement, you may want to adjust your SIPP investments to reduce risk. 

You may also need to start planning how you’ll withdraw your pension.

How Do You Make Withdrawals & What are the Tax Implications?

Withdrawals and tax implications need to be considered when you approach retirement, along with how you plan to access your SIPP funds and any lifetime allowance considerations.

You’ll be able to withdraw from your SIPP once you’re 55 (or 57 from 2028).⁹

Accessing funds before this age could lead to hefty tax charges, which may seriously deplete your pension savings.¹⁰

Taking Income from Your SIPP

There are several ways to take income from your SIPP, including lump sums, drawdowns, or buying an annuity.

Taxation of SIPP Withdrawals

SIPP withdrawals are usually 25% tax free, with the remaining 75% taxed as income at your marginal rate.

Common Questions

In Conclusion

SIPPs offer a broad range of investment options and, depending on your circumstances and goals, can be an excellent tool for consolidating various pension pots, making contributions flexible, and providing possible tax benefits. 

However, these products also require active management and careful decision making to navigate the investment risks. 

Given the complexity of pension planning, being able to answer the question, ‘How do SIPPs work?’ can empower you to take control of your retirement planning in a flexible and potentially tax-efficient manner.