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

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 have pension freedoms in what you invest in- there are a wide range of assets, including stocks, bonds, and property
3. SIPPs usually have lower fees than other pension schemes
4. You can access your money using income drawdown from the age of 55 (this may change in the future)

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 income tax has been deducted from your pay check) whereas ISAs are tax-free on the way out (you contribute to them from your payslip before income tax, but can make unlimited withdrawals without paying capital gains tax). This is important. There sadly aren't any options that are tax free on the way in and out - that would be too easy.

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 by no means have to start withdrawing money as soon as you reach the eligible age.

You 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 SIPP withdrawal options?

Well, the first 25% of the money you withdraw will be tax free, and you can chose to take this either in one 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 out a tax free lump sum all in one go; the first 25% of your next withdrawals will be tax-free. The advantage of this is that the 25% continues to grow as it isn't being liquidated - although of course this means that it is subject to investment risk.

Once you have taken this 25%, as a tax free lump sum or in instalments, your pension has become what's known as "crystallised."

Crystallising your pension scheme is the process of selling the investments in the stock market that make up your pension contributions and are allowing your money to grow.

You then have a number of withdrawal options as to how to take the remaining 75%, which will be liable for tax.

1. Income drawdown: an income drawdown plan is one option for SIPP withdrawals, where part of your money remains invested and is received in part as income- this is known as either income withdrawal or more commonly income drawdown. 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 product that enables you to get payments in yearly or monthly instalments, meaning you will continue to receive money in a similar fashion to a salary.This can be beneficial as you will know the amount of money from your SIPP fund you will be receiving, as you determine- based on the amount saved within the pension pot, what your 'retirement income' will be. If you have health issues you may be eligible for a higher payment rate. If you happen to pass away before receiving the contents of the whole fund, it can continue to be payed to whoever you have selected.
3. Full cash-in: as you might have guessed, the final option is to take the entire fund in one 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. This is arguably not the most optimal way to withdraw from your SIPP fund, as depending on how large the pot is, you could find yourself giving up almost half the sum.It is always a good idea to talk to your financial adviser before making any decisions on how you are going to go about withdrawing your funds, as most of the time decisions will be irreversible- and you want to be in the best financial circumstances you can!

SIPP Options

Let's say you 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.

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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 fund, 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. You should also think about how you currently pay tax and whether this will be affected by taking pension income down the line - weighting towards your tax free lump sum will mitigate this.

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. Before deciding to withdraw from your SIPP, either with monthly or annual income, you should either be fully aware of the likelihood of paying tax and consult with an accountant if necessary. This is particularly important for our users who are paying into an overseas bank account.

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. You will also be able to decide when best to withdraw funds, check on funds withdrawn, plan for inheritance tax and retirement ambitions, as well as monitor the funds your pension invested in.