Sipps versus ISAs
A SIPP is a self-invested personal pension. They are taken out between you the individual, and the pension provider. However, SIPPs offer much wider investment powers than are generally available for personal pensions and group personal pensions. The wider investment powers can allow you to invest in a wide range of assets, including:
- Quoted UK and overseas stocks and shares
- Unlisted shares
- Collective investments (such as OEICs and unit trusts)
- Investment trusts
- Property and land (but not most residential property) insurance bonds.
A SIPP can also borrow money to purchase some investments. For example, a SIPP can raise a mortgage to part-fund the purchase of a property. Such properties would normally then be rented out and the rental income, received by the SIPP, can be used towards servicing the mortgage repayments and the costs of running the property. Not all SIPPs allow you to invest in the full range of allowable investments. SIPPs that hold specialist investments (such as property) may be liable to pay higher charges than schemes that hold ‘mainstream’ investments.
An ISA (Individual Savings Account) or New ISA is a class of retail investment arrangements available to residents of the United Kingdom. Payments into the account are made from your after-tax income. The account is exempt from income tax and capital gains tax on the investment returns, and no tax is payable on money withdrawn from the scheme either. Cash and a broad range of investments can be held within the arrangement, and there is no restriction on when or how much money can be withdrawn. Many restrictions were significantly relaxed from June 2014 when the New ISA name was introduced – but we just call them ISAs throughout the Blog. For the tax year 2015-16, the new ISA allowance is £15,240 for cash or Stocks & Shares ISAs and £4,080 for Junior ISAs.
What’s better, an ISA or a SIPP? What are the tax differences?
The SIPP is more tax efficient because you receive tax relief on your contributions, so the gross amount grows and compounds up. The government grosses up pension contributions according to your tax band. This is done automatically for basic-rate taxpayers, but higher-rate taxpayers need to claim back their extra relief separately. Even non-taxpayers also receive 20% basic-rate relief (up to £3,600 gross). Basic rate and non-taxpayers making a net contribution of £1,000 receive £1,250, higher-rate taxpayers get £1,667, and those on 50% get £2,000. However, tax is payable when an income is taken from your SIPP.
In comparison, an ISA gives you no tax relief on the way in, so there is no compounding effect – but the proceeds are free of tax when you take them out.
The truth is that self-invested personal pensions are more tax efficient than individual savings accounts, but ISAs are more flexible because you can draw income at any time. However, for most of us it makes sense to use both SIPPs and ISAs when planning a retirement strategy – the relative importance of one over the other depending on how you think your tax status will change over time and how much flexibility you need.