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Pension edge: Michael Fairweather

A self-invested personal pension gives you a much greater choice of investments than can normally be offered by a packaged pension. A Sipp separates the role of pension provider and investment provider, allowing you to take personal control of the investment of your fund.

Just like personal pensions, Sipps offer tax relief on contributions at 40 per cent for higher-rate taxpayers. The fund will grow free of capital gains tax and 25 per cent of the fund can be taken as a tax-free lump sum at retirement.

The Inland Revenue has recently confirmed that contracts for difference are an acceptable investment for Sipps. This has introduced issues that Sipp providers are having to address, as there is the possibility of losing more than the original stake.

Sipp providers will therefore need to limit the liability to the value of the assets of the pension scheme.

CFDs allow you to trade in individual shares without putting up the full underlying contract value and offer substantial advantages over normal share trading.

You can short sell to gain from a stock or share that loses value. Additionally, there is no stamp duty payable on a CFD, unlike trading directly in the underlying shares. The attraction of being able to invest in CFDs free of capital gains tax within a Sipp is beginning to catch on.

CFDs are derivatives that are settled daily on the basis of movements in the prices of the underlying assets and are most commonly created in major international share market indices and their individual constituents.

A CFD is a contract between a client and a broker or market maker. The basic unit of account for an individual share CFD is one share (subject to a minimum acceptable deal size) valued at 1p per point.

The unit of account for an index CFD is usually the index itself, for example, one FTSE 100. The value of the contract is the number of points in the index times the value per point. UK indices are valued at £10 per point.

If you think that the price of the underlying share or index is going to rise, you buy a contract at the offer price. If you think that the price of the underlying share or index is going to fall, then you sell a contract at the bid price.

When you place a deal, the broker requires a deposit, known as the initial margin, which is usually 10 to 20 per cent of your underlying exposure. But this can be higher for risky or illiquid stocks and also for novice investors.

Margin trading gears rates of profit and loss. Gearing is one of the main reasons for CFD trading.

Although CFD buyers never hold the underlying shares, the cash equivalents of dividends are credited to their accounts at between 80 and 90 per cent of the full distribution. Short sellers rebate 100 per cent of the dividend.

The charges associated with trading in CFDs are the bid-offer spread, which is the difference between the price you buy at and the price you sell at, dealing commission and the cost of carry. When you buy a CFD, the broker is effectively lending you money. CFD buyers are charged daily interest known as cost of carry or long interest.

CFD sellers are deemed to have lent money to their brokers and receive daily short interest at the benchmark rate minus the broker&#39s margin.

Trading in CFDs is often compared with spread betting but the main difference is that CFD spreads are determined by the market while betting spreads are set by the bookmaker and tend to be wider.

CFD buyers – but not spread betters – receive a percentage of the cash equivalent of dividends while CFD short sellers rebate the dividend equivalent.

The main difference between CFDs and share dealing is that stamp duty is not payable on CFD trades whereas it is payable at 0.5 per cent on UK share purchases.

However, CGT is payable both on CFDs and share dealing when gains arise above an individual&#39s annual CGT allowance, which is £8,200 for the current tax year.

For investors who are likely to make capital gains of more than this amount, a Sipp is attractive as it provides a CGT-free environment in which to invest.

CFDs are by their nature high-risk investments and it is normally inadvisable for any client to invest 100 per cent of their pension fund in these assets. However, as part of a carefully constructed pension investment portfolio, CFDs can be used as a hedge against market downturns or to accelerate performance in rising markets to provide the icing on the cake of the overall investment performance.

Michael Fairweather is an IFA at i-Sipp


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