Shares digital

Investors can use SIPPs to actively manage their pension portfolios

by David Burrows

You might think that when stock markets are as volatile as they are, people would be less inclined to take responsibility for their pension investments – but not so according to James Daly of TD Waterhouse.

‘We have had a record year for new business in SIPPs. I would suggest there are those who see mediocre performance of managed funds in what is a testing climate and compare them with their own better-performing share portfolio. Understandably, they may think they could improve their pension returns by taking more of an active interest themselves.

‘I think since A-Day (April 2006) investors have become far clearer with regards to what can and what cannot be put into a SIPP. The breadth of investment choices open is now sinking in.’

These sentiments are shared by Michael Smith, head of technical at Pointon York Sipps Solutions. ‘Prior to A-Day there was a distinct lack of clarity, whereas now there is a list of what qualifies for a SIPP investment,’ says Smith. ‘It is far more black and white now and I think SIPP investors are starting to make full use of some of the more exotic investments now available to them.’

In the current economic climate investors like the opportunity to invest in things such as structured products or hedge funds. Diversity and risk control is therefore king, but how far do SIPPs provide these choices for investors and, more to the point, are investors using them?

‘Firstly, investors can invest in hedge funds and in structured products,’ explains Smith. ‘We are seeing SIPP investors use all the investment vehicles open to them but you have to remember that we are at the top end of the market. People are putting hedge funds in their SIPP but the minimum investment typically for a hedge fund is £100,000. With a cheap and cheerful SIPP, providers will be more limiting on what they will allow you to invest in. For instance insurance companies are not allowed to invest in unquoted shares.’

The bigger picture

Daly agrees that SIPP investors are looking at the bigger picture when it comes to what the new rules allow: ‘Undoubtedly, investors are looking at things like unquoted shares but also they are increasingly aware of the option of putting short instruments in a SIPP – things like covered warrants or currency warrants have a certain appeal. I know of someone who has a SIPP entirely made up of covered warrants – which is very extreme and not really advisable. With something like covered warrants, even most of the execution-only SIPPs will cater for you. Also AIM shares are allowed and they have attracted interest’

There is also the benefit of using CFDs in a SIPP to hedge existing positions in a SIPP portfolio. Investors usually have the option to split their SIPP fund so that part of it is in a CFD SIPP and another part is in a traditional portfolio.

‘From what we have seen so far there hasn’t been a huge appetite for CFDs in a SIPP,’ says Daly. ‘I think it is a step too far for a lot of investors.’

Protected rights

Protected rights is one of the big topics of discussion in the SIPP market and this autumn might bring with it some significant changes, as Smith explains: ‘Rather than have a second state pension via National Insurance contributions, the option is there to contract out and get a rebate back to your chosen pension fund. Until now the rules have prevented you from doing this with a SIPP. From October this is scheduled to change and you should be able to bring this money into a SIPP, where it can then be invested in the stock market.

‘For people with personal pensions this is a huge issue. For higher earners the second state pension contribution could be quite big, say £80,000, so being able to transfer this into a SIPP is hugely significant. It is currently draft legislation so it is not set in stone yet but we would like to think there will be no U-Turn!’

Not so hot property

Commercial property and REITs have until recently proved popular additions to a SIPP portfolio – largely as a diversification from equities however the appetite has waned as the property market has slumped.

‘In the last few years we have seen an enormous amount of interest in [non-residential] property but this has tailed off a bit,’ says Smith. But he adds that there have been areas that needed clarity, particularly with regard to revenue derived from rental of hotel rooms.

HMRC had suggested that such income received into a SIPP might be taxed as trading income, on the basis that the SIPP is benefiting from a direct return on the trade of renting out rooms.

Smith says that tax position can now be clarified. ‘If the return to the SIPP is wholly based on the income obtained from renting the room or a pool of rooms (.e. a percentage of the room rate), with no payment made relating to the profit made from the services of the hotel, then the trading income concern will not normally be an issue.

‘Most of the hotel room investments we come across will fall into this category. There is sometimes a fine line between hotels and holiday apartments [which are not qualifying investments]. The general rule of thumb is there should be no right of use. The room must be part of a genuine hotel, not a block of flats, holiday home or timeshare complex. Investors must beware that some overseas property may be described as ‘a hotel’ in that particular country, but would not necessarily be classed as such under the UK SIPP tax legislation.’

There is no SIPP tax definition as such, but HMRC would expect the letting arrangements, accommodation and services provided to be those that are usually provided by a hotel. In the UK, for example the building would be expected to be within Class C1 of UK planning regulations.

There must be no right of occupancy associated with the investment, as this would mean that the investment would be classed as residential property and both the SIPP and the investor would incur significant tax charges.

Some misconceptions about SIPPs

Anyone taking out a SIPP has to understand the role of the trustee, which is responsible for all the administration under HMRC rules. The trustee has to take control of the assets and put them into a trust under its name.

The trustee effectively sits between you and the assets, ensuring the SIPP adheres to government restrictions on investments.

But as Georgina Mitchell, head of investment services at Redmayne Bentley, explains, one of the misconceptions about SIPPs is that they are your assets. ‘The only thing that the investor is entitled to is the benefits when they go to drawdown. If you have £500,000 in a SIPP and are under 55, [drawdown is not allowed until age 55] you can’t ring your broker and say you want to sell everything. It’s amazing the number of people who don’t understand this.’

Clearly you can’t have it both ways but of course the trade off for this restriction on access to the pension pot is of course the upfront tax benefits of SIPPs, dependent on your marginal rate.

Arrival of QROPS

The ‘Pensions Simplification’ in April 2006 meant radical changes were made to the rules governing transfers of UK-tax relieved pension benefits. From this date any frozen UK pension, including those in drawdown, could be transferred to a HMRC registered QROPS (Qualified Recognised Overseas Pension Scheme). As Smith explains, what was a measure designed for UK citizens who have moved abroad or non UK citizens who are working in the UK, is likely to be used by wily SIPP investors planning to head for retirement in Spain or Portugal.

‘I know of SIPP advisers who are advising client to set up a SIPP, take the tax relief while in the UK and then transfer to a QROPS and then wait six years,’ says Smith. ‘After that time there is a lot more flexibility on how you take your money.’

The reason for this is that if you go overseas you are bound by the same pension rules as in the UK – but after six years as a non-UK resident these rules no longer apply.

‘I think those in SIPPs may look to exploit this loophole,’ explains Smith, ‘but it is not something we recommend. The Revenue are likely to change the rules so it is not something at Sipp Solutions we would look to get involved in’.