Originally published at: How to use your SIPP to invest tax efficiently – InvestEngine Insights
A self-invested personal pension (SIPP) is a flexible way to save for retirement, giving you control over how and where your money is invested.
It’s particularly beneficial for higher earners or self-employed individuals who want to take advantage of tax relief while building a substantial pension pot.
By using your SIPP strategically, you can make the most of its tax advantages and investment opportunities. Here’s how to approach it.
What is a SIPP?
A SIPP allows you to manage your pension investments directly. Unlike traditional workplace pensions, which are often restricted to a limited range of funds, SIPPs provide access to a diverse selection of investments such as shares, bonds, exchange-traded funds (ETFs), and even commercial property.
This level of choice enables you to tailor your investments to your financial goals, risk tolerance, and retirement timeline. Whether you prefer hands-on management or a more passive approach, SIPPs offer the tools to align your pension with your broader investment strategy.
SIPPs are particularly appealing for individuals who wish to consolidate multiple pension pots into one flexible account, giving a clearer picture of overall retirement savings.
They are also a good choice for those planning to invest in asset classes not typically available through traditional pensions, such as individual stocks or alternative investments.
Make the most of pension tax relief
Tax relief is one of the key benefits of contributing to a SIPP. When you make a contribution, the government adds an extra amount:
- Basic-rate taxpayers receive 20% tax relief automatically. For example, if you contribute £800, the government adds £200, making your total contribution £1000
- Higher-rate taxpayers can claim an additional 20% relief (25% for additional-rate taxpayers) through their self-assessment tax return. This means a higher-rate taxpayer’s £1000 contribution effectively costs just £600.
Reinvesting any additional tax relief you reclaim can boost your overall savings further. Over time, this compounding effect significantly enhances the value of your pension pot. For example, regularly reinvesting higher-rate tax relief into your SIPP could add thousands to your retirement savings over the long term.
For higher and additional-rate taxpayers, it is crucial to claim this extra tax relief through self-assessment or by contacting HMRC.
If unclaimed, you could be missing out on thousands of pounds annually, which can significantly impact your long-term pension growth. The reclaimed amount can also be reinvested into your SIPP, taking advantage of further tax relief and compounding growth.
Understand the annual allowance
The annual allowance is the maximum amount you can contribute to your pension each year and still receive tax relief. For most people, this is £60,000 or 100% of their earnings, whichever is lower. High earners with adjusted incomes above £240,000 may have their allowance tapered to as little as £10,000.
If you haven’t used your full allowance in the past three tax years, you can carry forward unused amounts. This allows you to make larger contributions in a single year, potentially maximising your tax relief. Ensuring you don’t exceed these limits is crucial to avoid tax penalties.
It’s also worth noting that non-earners can contribute up to £2880 annually into a SIPP and still receive basic-rate tax relief, effectively turning their contribution into £3600. This can be a valuable strategy for building retirement savings for children or non-working spouses.
Reduce your tax bill with a SIPP
Investing in a SIPP offers several tax advantages:
- Income tax relief: Contributions reduce your taxable income
- Tax-free growth: Investments within a SIPP are shielded from capital gains tax and income tax
- Inheritance tax efficiency: SIPPs are typically excluded from your estate, making them an effective tool for passing wealth to your beneficiaries.
By contributing regularly and taking full advantage of these benefits, you can build a larger retirement fund while minimising your tax liabilities. For example, higher earners may find that reducing their taxable income through SIPP contributions allows them to move into a lower tax band, offering additional savings.
Minimise investment fees
Fees can have a significant impact on the growth of your pension over time. A 1% annual fee can reduce your portfolio’s value by almost 25% over 40 years.
When selecting investments for your SIPP, prioritise low-cost options such as ETFs. These products typically have lower fees than traditional mutual funds and can offer broad diversification. Minimising fees ensures more of your money is working towards your retirement goals.
It’s also helpful to periodically review your investment choices and platform charges. Transferring your SIPP to a provider with lower fees could save you thousands over the lifetime of your pension.
Diversify your portfolio
Diversification is an essential principle of successful investing. By spreading your investments across different asset classes, industries, and geographic regions, you reduce risk and increase the potential for steady growth.
A well-diversified SIPP might include a mix of equity ETFs for growth, bond ETFs for stability, and other assets that align with your risk tolerance. Regularly reviewing and rebalancing your portfolio ensures it stays aligned with your goals and market conditions.
For example, during periods of market volatility, rebalancing may involve shifting funds from high-growth equities to more stable assets like bonds, ensuring your portfolio maintains its intended risk profile.
Plan withdrawals strategically
Careful planning is key when it comes to withdrawing from your SIPP. Once you reach 55 (rising to 57 in 2028), you can access your pension savings. Up to 25% of your pot can be taken as a tax-free lump sum, while the remainder is subject to income tax.
To minimise tax, consider spreading withdrawals over several years to keep your income within lower tax bands. Leaving funds invested for as long as possible allows them to continue growing tax-free, maximising the value of your pension pot.
It’s worth exploring the advantages of phased drawdown, which allows you to take smaller, regular amounts from your SIPP rather than a single lump sum. This approach can provide a steady income while keeping a significant portion of your savings invested.
Maximise household savings
If you’re married or have a partner, contributing to their SIPP can be a tax-efficient way to boost your household’s retirement savings. Non-earning partners can receive up to £720 in tax relief annually on contributions of £2880.
This approach not only increases total pension savings but also provides flexibility in managing retirement income, as each partner’s withdrawals are taxed individually. By spreading pension savings between two people, it’s often possible to keep more income within lower tax bands during retirement.
Take advantage of the lifetime allowance changes
The abolition of the lifetime allowance in April 2024 means there is no longer a cap on the total value of pension savings that can benefit from tax relief. This change makes SIPPs particularly attractive for those with substantial savings or high earning potential.
Without the lifetime allowance, savers can invest more confidently, knowing they won’t face additional tax penalties for exceeding a specific pension pot size. This reform supports long-term wealth building within a pension framework.
Regularly review and adjust your investments
Your financial goals and circumstances are likely to evolve over time, so it’s important to review your SIPP portfolio regularly. Monitoring performance and rebalancing investments ensures your pension remains aligned with your objectives.
Set a schedule to assess your portfolio annually or biannually. This proactive approach can help you identify opportunities to optimise your asset allocation and adjust to changes in the market or your personal circumstances. For example, as you approach retirement, you may choose to shift towards lower-risk investments to preserve capital.
Why consider the InvestEngine SIPP?
The InvestEngine SIPP offers a cost-effective way to manage your retirement savings, with features designed to maximise your pension’s growth:
- Zero account fees: No charges for maintaining your SIPP account (ETF fees still apply)
- Customisable portfolios: Choose your own investments or let experts manage them for you
- Low-cost ETFs: A cost-effective way to achieve diversification
- Flexible contributions: Start investing with as little as £10 and set up automated contributions to stay on track.
InvestEngine also provides tools for monitoring and managing your investments, helping you make informed decisions about your retirement planning.
A SIPP is a powerful tool for tax-efficient investing, offering the flexibility to build a retirement fund tailored to your needs. By understanding the benefits of tax relief, diversification, and strategic withdrawals, you can make the most of your pension savings.
The InvestEngine SIPP simplifies the process, offering cost-effective solutions to help you achieve your financial goals. Whether you’re new to pensions or looking to enhance your existing savings, it’s worth exploring how a SIPP can support your retirement plans.
Important information
Capital at risk. The value of your portfolio with InvestEngine can go down as well as up and you may get back less than you invest. ETF costs also apply.
This communication is provided for general information only and should not be construed as advice. If in doubt you may wish to consult a professional adviser for guidance.
Tax treatment depends on personal circumstances and is subject to change, and past performance is not a reliable indicator of future returns.