But they are not only attractive to investors who are building up their retirement savings. People who get to retirement and want to opt for income drawdown rather than buying an annuity straight away are also turning to Sipps in order to help preserve the capital value of their pension fund.

How the policies work

Sipps are subject to the same rules as ordinary personal pensions. They are set up under a discretionary trust and money cannot be taken out except to provide a pension, tax-free lump sum or death benefits. Trustees are required and one will normally be a professional whose job it is to ensure that the Sipp is managed in accordance with Inland Revenue rules and to safeguard the assets within the pension fund.

Although any type of company may administer a Sipp, not all can act as trustees so this role may be outsourced. The Sipp provider deals with the purchase and sale of the investments. These investments are ring fenced within the policy.

One advantage of this arrangement over conventional pension plans is that the investments won't be influenced by anything that happens to the provider unlike, say, investments in an insurer's with-profits fund which may be affected by other business decisions made by the company.

At retirement, investors have the same options as they would with an ordinary pension, they can take a tax-free lump sum of 25 per cent of their fund and use the remainder to buy an annuity or opt for income drawdown.

The main advantage of Sipps over traditional personal pension plans is the wide range of investment choices available. With a traditional personal pension, investment was normally restricted to the pension company's own managed funds although nowadays more and more companies are offering additional funds run by external managers.

However, with a Sipp, policyholders have much more freedom. Permitted investments include unit trusts and Open-Ended Investment Companies (Oeics) , investment trusts, insurance company funds, UK shares, overseas shares, UK gilts, corporate bonds, futures and options, permanent interest bearing shares, traded endowment policies, commercial property and cash deposits.

Unit and investment trusts have tended to be the most popular options for Sipp investors because they are cost efficient and investors can choose the best fund managers for each asset class or geographical region. It is also easy to switch between funds when a change of investment emphasis is required or when managers move.

However, in recent years there has been a growing interest in investing in commercial property through a Sipp. Some business people have used Sipps to buy their own business property but where individual Sipp investors do not have adequate resources to purchase their own properties, they may be able to buy a share in a property through a syndication arrangement.

Advantages of buying property through a Sipp is that the rental income is paid gross and when the property is sold it is free from capital gains tax. At present it is not possible to invest in residential property although this rule may be changed in the Budget. Shares in private companies, alternative investments such as antiques or art, and commodities are also not allowed as investments in Sipps.

Charges on a Sipp usually consist of a flat-rate set-up fee of between £100 and £500 plus an annual administration fee of around £400 to £500. In addition, many providers charge a transaction fee each time investments are bought and sold of say £25.

Sipps with a commercial property option often charge more and there may be an extra annual fee. When the Sipp provider is an insurance company, investors may be offered a reduction in fees if part of the pension portfolio is invested in the insurer's own funds.

Newer entrants to the Sipp market have introduced more competitive fee structures but there is usually still an annual fee. Besides the charges for the Sipp itself, investors need to take into account any annual management charges on the investments within their plan. If an independent financial adviser or some other investment adviser is being employed to manage the investments, this will also add another 0.5 to 1 per cent a year to the cost.

The charges on Sipps mean that they are generally not cost-effective for investors with pension funds of less than £100,000. Even at this level, charges are likely to amount to around 2 to 2.5 per cent a year, compared with 1 per cent on a conventional stakeholder or personal pension. So investors will have to be confident that they can achieve annual investment returns which are more than 1-1.5 per cent higher than a conventional scheme if they are going to be any better off. Lower charges may be made for 'execution only', do-it-yourself Sipps but these will only be suitable for investors who feel they have the time and expertise necessary to run their own pension portfolios.

If they make a wrong decision, they will only have themselves to blame, whereas if a professional investment adviser gives them inappropriate advice they may be able to get compensation.