Pensions For All The Family

Here's how to find super-cheap pensions for adults and children, and even reclaim tax that they haven't paid!

In recent months, I've been investigating how to create an ultra-cheap pension to help fund my retirement.

One avenue is to find a simple, low-cost stakeholder pension, as annual management charges on stakeholder pensions must not exceed 1.5% a year. However, past experience has taught me not to put my faith in fund managers, insurance companies and other pension providers, so I've rejected this option. Instead, just before the end of the 2006/07 tax year, I opened a type of 'Do It Yourself' pension known as a Self-Invested Personal Pension, or SIPP.

A SIPP is simply a tax-free wrapper around a collection of investments which are chosen and managed by an investor, with or without the help of professional advisers and investment managers. Of course, SIPPs offer the same tax advantages as other pensions, but what makes them attractive is the freedom, flexibility and control over their assets that investors enjoy.

All dividends (the income paid by shares), interest and capital gains earned by pensions are tax free, which makes a pension a leading contender for saving for retirement. Furthermore, since the radical reforms introduced on pensions A-Day a year ago, you can contribute any amount you wish into pensions. However, you only receive tax relief on contributions worth up to 100% of your earned income, subject to a limit of £225,000 in the 2007/08 tax year.

For basic-rate taxpayers, 22% tax relief on pension contributions turns £78 into £100. Higher-rate taxpayers (who pay tax at 40%) can reclaim further tax relief through their tax return or a form PP120, so a £100 contribution costs them just £60. Thus, particularly for higher earners, SIPPs are a very attractive investment vehicle.

In order to maximise my investment returns, I must keep administrative and other charges in my SIPP to a minimum. Hence, I spent days checking the details of over eighty different SIPPs to see which would best suit my requirements. In the end, I chose the award-winning HL Vantage SIPP from Hargreaves Lansdown, which my number-crunching showed is the cheapest SIPP for my needs. I chose it because it has no set-up fees, no or low ongoing management fees, low share-dealing charges, plus it offers hefty discounts via the HL fund supermarket.

As a freelance writer, I have a very irregular income, so I pay myself only a modest monthly wage. However, UK residents -- even non-taxpayers and children -- can contribute up to £3,600 a year into a pension and earn tax relief on this sum, regardless of how much tax they actually have paid. Thus, I paid £2,808 into my SIPP last month, which will automatically become £3,600 after £792 of tax relief is added. As a higher-rate taxpayer, I can reclaim a further £648, which means that my £3,600 contribution costs me just £2,160. Now that the new tax year has started, I will add a further £3,600 this month.

My cunning plan is to then invest my entire £7,200 in the cheapest index-tracking fund that I can find. The very cheapest index trackers (such as the Fidelity Moneybuilder UK Index OEIC, which has a total expense ratio of 0.3% a year) attract an extra management charge of 0.5% a year inside the HL Vantage SIPP. Therefore, I've rejected these in favour of the Legal & General UK Index fund, which has a total expense ratio of just 0.52% a year, but avoids the extra administration fee charged by HL's SIPP.

I reckon that paying total charges of 0.52% a year for a simple, easy-to-administer pension is a bargain. Hence, at the same time, I opened SIPPs for my five-year-old son and three-year-old daughter, too. Even though they've never paid tax in their young lives, they qualify for the same £792 a year of tax relief that I've claimed.

What's more, I reckon that paying in a total of £3,600 a year for each of my children for the next five years will provide them with a half-decent pension when they retire in sixty or seventy years' time, regardless of any other pension provisions they personally go on to make. Indeed, next week, I'll show you how to build a multi-million-pound pension pot for a child by investing relatively modest sums. Watch this space!