Do You Need a SIPP & What are the Withdrawal Rules?

Wed Jul 20 2022

Introduction

SIPPs (self-invested personal pensions) have been around since 2005 and are a great way to save for retirement. But wait, you're already contributing to your workplace pension - why do you need another one? This is a particularly relevant question to ask for those who are saving beyond their workplace pension (which is hopefully almost everyone), and are stuck between contributing to their ISA, or opening another pension. Both are for the long term, so which makes more sense?

To go one step further, do you even need a SIPP? What are the SIPP withdrawal rules? And how do they differ from traditional pensions? In this post, we will discuss SIPPs and their benefits, as well as the rules governing withdrawals, so you can make an informed decision.

What are SIPPs and what are their benefits

SIPP stands for Self-Invested Personal Pension. It is a pension scheme that allows the individual to make their own investment decisions within a set of rules laid down by HMRC. As the name suggests, you have much more autonomy over what happens to your money inside the pension, than a workplace pension where you choose from a set of pre-assigned investment choices. 

The main benefits of having a SIPP are:

  1. You have control over where your money is invested
  2. You can invest in a wide range of assets, including stocks, bonds, and property<br>
  3. SIPPs usually have lower fees than other pension schemes<br>
  4. You can access your money from the age of 55 (this may change in the future)<br>

Now, if you're still many years from retirement, you will likely be wondering why on earth you should be paying so much attention to your pension. Well, this won't be for money that you'll need within the next few years but with the rising cost of living and lack of wage growth compared to inflation, it's never been more important to start saving for retirement early. You can see how this fits into an ordered personal finance plan in our guide here.

What you want to do with the money you're saving will largely dictate where it goes - a general rule is that pensions are tax-free on the way in (as your contributions are made before tax has been deducted from your paycheck) whereas ISAs are tax-free on the way out (you contribute to them from pre-taxed income, but can make unlimited withdrawals without paying capital gains tax). This is important.

What are the SIPP withdrawal rules?

So, as with any defined contribution pension (where you make regular contributions), you can officially start taking money out of it aged 55. That being said, you have no obligation and can actually continue to make contributions that benefit from tax relief until age 75, all while your pot continues to grow. Note also that the date you choose to withdraw money has no official link to your retirement date: you can start drawing down on it before you officially retire, as long as you're passed the age of 55.

Also note that from 2028 onwards, the government plans to raise the age at which you can access money in your SIPP to 57, given the rising trend in retirement age. Keep an eye on changes in SIPP withdrawal rules to be sure on what might affect you.

Are there any penalties for withdrawing money early?

Depending on your pension provider, you may be able to withdraw money from your SIPP early. However, do note that there are usually penalties for doing so. If you just want early access to your money, you're likely to be charged a punitive withdrawal fee by your provider. In addition, you'll also face an eye-watering 55% tax rate on the withdrawal amount. So, best avoided really.

Exception: medical grounds. If you have medical grounds for early retirement, most providers will allow you to withdraw from your SIPP without penalty - the 55 retirement age no longer applies, and you will be able to make withdrawals as if you were past this age. Specific details vary between providers. In the absolute worst case that you are diagnosed with a terminal illness, you may be able to take it all out as a lump sum.

How much money can you withdraw from a SIPP?

So, you've turned 55. What are the options? Well, firstly you can take the first 25% tax free, either as a lump sum or in instalments. Following that, the remaining 75% will be available for withdrawal at standard marginal tax rates, as if it were regular income.

If you choose not to take the 25%, then from every future withdrawal you make, the first 25% will be tax-free. The advantage of this is that the 25% continues to grow as it isn't being liquidated - of course this means that it is subject to investment risk.

If you do decide to take it, once this 25% has been taken, your pension has become what's known as "crystallised." You then have a number of options as to how to take the remaining 75% which is liable for tax.

  1. Income drawdown: here you move some of the money into an income drawdown plan, where it remains invested but can be drawn down, so it continues to grow in the background. Of course, this means you need to assess the risk profile of your assets - it will remain subject to market volatility and so needs to be uninvested with ample time for withdrawal to avoid the risk of liquidating required assets during a market downturn.
  2. An annuity: this is a financial product which gives you the chance to exchange your investment principal for a fixed rate guaranteed income for life, depending on provider. In a morbid twist of fate, those with health problems will naturally be offered a higher payment rate, in the likelihood that they will not live too much longer.
  3. Full cash-in: as you might have guessed, the final option is to take the whole lot as a lump sum. Now, this is not an option that is always offered so be sure to check the small print of your provider. It may also come with small penalties, and as mentioned above, will be taxed at your marginal income tax band. Which means that depending on how large the pot is, you could find yourself giving up almost half the sum.

SIPP Options

Let's say you do choose to open a SIPP in the UK: what are your options? We've rounded up the top 5 providers, and what they're most well known for. Those with larger portfolios will want to avoid % fee based options which become irritatingly large on large accounts, and stick to platforms like interactive investor which offers flat rate platform and transaction fees. Note also that of these, Vanguard is the cheapest but also the only one which limits you to investing in its own funds: fine for those who are only interested in the low-cost index funds which made it famous, but not so much for everyone else. Some of these also offer deals if you have an ISA with them already, so note this when making your decision. 

It is possible to change down the line, but there may be transfer penalties for doing so. Be aware! As always, don't forget to read all the fine print and try and have some forethought about what you might do with your holdings in the future.

SIPP withdrawal rules - UK provider comparison

So, SIPP or ISA?

The killer question. The answer is that if there's any single small chance that you might need the money before retirement, you should put it in your ISA. You might want to consider just using up all £20k/year of your ISA allowance and then put the excess into a SIPP, or something to that effect. However, if you're slightly more settled in life and have plenty of savings to draw down on before dipping into this cash, a SIPP is a good option. You can read more on ISAs in our guide here

Wrapping Up & managing your pensions with Strabo

Given that SIPP withdrawal rules can be fairly onerous, they should be treated with caution by younger investors. However, remember that they are one of the tools in your wealth creation toolkit, and as such it's vitally important to understand how they work, why they were established and what they can do for you as part of a portfolio, especially as you move through life into your later years. Many SIPP providers have open banking access which means that you can also track their progress on the Strabo dashboard. This will give you a much more comprehensive view than the provider platform, and allow you to manage your pensions holistically alongside other assets including bank accounts, brokerage accounts, your ISAs, and any property you may have accumulated. As always, you can find the signup for this at the foot of the page!

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