SIPP vs ISA explained – Which is Best For You?
Hi guys! Welcome to the tax-free investing blog. Today’s post is all about retirement investing. Specifically, which is better for you; SIPP vs ISA! You might be wondering what these are, but don’t worry! That’s what this blog is for and hopefully by the end of it you will see a clearer path.
If we haven’t met before, I’m Chris Bourne, I’m a financial planner here in the UK specialising in wealth management, retirement planning and tax planning and I help people achieve financial independence early tax efficiently. If you want to learn how to build tax free growth and income by understanding tax allowances, wrappers and reliefs, my blog will be right up your street! If you prefer video format, then check out my YouTube Channel! I post weekly videos to give you some fantastic, simple tips to get you to financial freedom.
But for now sit back, relax and let’s get into it!
So… should it be the SIPP or should it be the ISA? Well, both are types of tax shelters for your money. They are different and both have great advantages for getting you to early retirement.
First let’s understand what they both are:
SIPP stands for Self-Invested Personal Pension so as the name kind of gives away, it’s a type of pension. A SIPP has much wider investment powers than a standard personal pension. This means it can invest into a larger range of collective investment funds such unit trusts and investment trusts. It can also invest into government securities like gilts, NS&I and direct shares as long as they’re listed on a recognised stock exchange.
The big difference though is that a SIPP can also invest into property. However, this has to be commercial property; it can’t be residential. This gives wide scope as there are numerous commercial enterprises that require buildings or land to operate from, and purchasing them with a pension protects all of the income and gains produced by those assets from tax.
Another advantage of the SIPP is that is allows you to borrow money in order to purchase an asset of a higher value. For example, if you were buying a property, you could borrow up to 50% of the value of the SIPP. So if you had £200,000 in your SIPP, you could borrow £100,000 and therefore effectively have purchasing power of £300,000.
So how much can you pay in?
You can pay up to £40,000 a year into a pension. This is only if you earn at least that much in salary or if your own company is making the contribution on your behalf, and it’s judged an allowable contribution. If you earn less than £40,000 a year, you can pay in up to what you earn. Anyone can pay in up to £3,600 even without earnings.
The big kicker with any type of pension contribution though is the tax relief you get on your contribution. This means the government add money on top of what you pay in. You read that right, 25% will be added to whatever you pay in! You can claim even more through your tax return if you pay tax at the higher rates.
So the SIPP is looking pretty good so far then. How does the ISA measure up?
ISA stands for Individual Savings Account. For the purpose of direct comparison we are looking specifically at the Stocks and Shares ISA in this article. As I have mentioned in previous blogs, ISA’s provide a great shelter from tax. If you want to find out more about different ISA’s, click here to read a more in-depth post.
Much like a SIPP, gains generated by your investments will be protected from tax. They also provide a generous contribution allowance of £20,000 a year. This isn’t linked to earnings so anyone can pay that much in. However, they don’t provide tax relief on top of your contributions like SIPPs do, and they don’t allow you to hold direct property in them.
BUT… Here’s the thing
Where the SIPP wins on investment choice and front end tax treatment, the ISA wins on flexibility and back end tax treatment. A SIPP will currently allow you to take 25% of your fund out free of tax, but the rest of the pot will be taxable as personal income. Whereas there’s ZERO tax when you take income or gains from an ISA.
You also can’t access any of your SIPP until you’re 55 years old currently, and that will rise to 57 when the state pension age rises to 67. You can take money out of your ISA at any time though which makes it highly appealing if you think you may need to access that money.
I know what you’re thinking… SIPP vs ISA…Tell me which one is right for me!
I’m sorry to tell you is there is no direct answer as a lot depends on your own situation and needs.
Just by virtue of the compound interest you get on the added tax relief, the SIPP often does produce a better net result over the long term. Even with you paying tax on the way out. The gap is smaller though if other types of taxable income will already be eating up your tax allowances in retirement, such as salary related company pensions or rental income from properties.
However, if your goal is FIRE (Financial Independence Retired Early), then a SIPP is going to restrict you because you won’t be able to access your money until your mid to late 50s. This will definitely hinder that early retirement! An ISA in that situation would give you much more flexibility, as you can access the money as and when you need.
So really there is no single, ultimate solution between a SIPP and an ISA
You need to work out the best path for you. The best results are usually gained by blending these and other tax wrappers together. My goal is to help by showing you how to open those different tax wrappers and how to best utilise them.
Until next time, stay savvy. Chris.