# Are SIPPs worth investing in?

Post March 2014 budget it appears that the SIPP fund will be entirely at the disposition of the SIPP investor from the age of 55.

The main advantages of a SIPP are as follows:

- It enables the taxpayer to move down by one tax band during periods in which income is taxed
- It enables the earnings of the fund to be reinvested tax free

# What is the worst case for a SIPP that does not accumulate value?

The concept can be fairly difficult to understand so an example can help:

A basic rate taxpayer whose earnings are £10,000/year puts £8,000 into a SIPP in March 2014. The purchase of the SIPP has no effect on the tax he pays. He will pay the same amount of income tax of £112 ((10000-9440) x 20%). However the SIPP will be grossed up by the government to £10,000. At a later date this person begins receiving his pension – say £5,700 state pension and a pension £4,300 from previous employment. He would pay the same tax of £112. Let’s assume he withdrew at a previous date his tax-free 25% and he wishes to withdraw the rest of his SIPP which amounts to £7,500. He would pay an additional tax of £1,500 (7500 x 20%). So in cash terms he would be £500 better off (2500+7500-1500-8000).

The above which in some ways a ‘worst-case-scenario’ illustrates a small advantage that is accorded to the basic rate tax payer which can be condensed as follows:

The sum is augmented by 25% and 25% of this can then be taken out tax-free, thus saving tax at 20% which would amount to 6.25% of the original sum (125% x 25% x 20%).

So there is effectively a minimum boost of 6.25% of the original sum. More savings can be made if the saver remains below the tax threshold in years when he is withdrawing funds. It should be noted that admin fees of typically 0.45% on the whole fund could apply, but these would normally be covered by the reinvested earnings of the fund.

If the saver succeeds in withdrawing all the fund without incurring tax (because his remaining personal allowance has enough left over after other income is included), then there is an effective augmentation of 25%.

# Are the SIPP earnings tax-free?

There is an often-quoted argument that the earnings of the fund can be reinvested tax free. This is true but one should note that the SIPP fund will often be earning dividend income which is not taxed below the higher rate tax threshold. So this argument has dubious validity except for the higher rate tax payer. One big advantage however is to have freedom from tax return reporting of one’s investing activity (dividend income, interest income, capital gains).

# How can a SIPP benefit a higher rate tax payer?

The mechanism is quite complicated to explain, but basically investment in a SIPP will result in a purchase of the SIPP asset at a discount equal to the marginal rate of tax (not strictly true if the investment is more than the amount of income in the marginal rate area. This applies to all marginal rates. So a 40% tax payer will get a 40% discount, meaning £60 of investment will by £100 pounds worth, and for a 45% tax payer, £55 will buy £100 worth.

# What happens with a SIPP if my income is in the £100,000 plus area where there is withdrawal of the personal allowance?

At this income level there is a marginal tax rate of 60% (40% plus 50p of personal allowance lost for each £1 above £100,000 which equates to 20%). Thus a £40 investment gives rise to a £100 of SIPP asset. For these big earners it should be considered the probability that their income stream when retired will be large and thus attract higher rate or basic rate tax during retirement.