When it comes to investing for your retirement, the advice is simple: start investing early in your life and give compounding as much time as possible to grow your nest egg. While this is sound advice, there are a multitude of different vehicles through which you can accumulate your retirement savings, with ISAs and SIPPs being two of the most common ways of doing it yourself.
However, which one is the more preferable of the two? Is the simplicity and flexibility of an ISA the more appealing? Or, do the tax advantages of a SIPP outweigh its relative rigidity?
Tax Differences
When it comes to tax advantages, SIPPs are viewed as the clear winner. That’s because, just like a personal pension, you receive tax relief on all sums invested through a SIPP. So, for example, if you are a basic tax rate payer, for every £80 you invest via a SIPP, the government will repay the £20 you would have paid in tax, thereby giving you £100 to invest. ISAs, meanwhile, offer no such tax advantage and are instead invested with post-tax income, thereby meaning that if you invest £80, the government repays no tax. As such, it is likely that a SIPP will grow faster and to a higher terminal value than an ISA, assuming they are invested in the same stocks.
Of course, while SIPP contributions have the advantage of being tax-free, withdrawals are taxed at an individual’s applicable income tax rate. This excludes the 25% lump sum that can be withdrawn tax free at age 55, but in the case of an ISA all withdrawals are tax free. As such, the tax benefit of a SIPP is largely negated by the tax on withdrawals, although for many people their tax rate in retirement may be lower than during their working lives, thereby making SIPPs more appealing compared to ISAs from a tax perspective.
Employer Contributions
For many employees, a SIPP is more preferable to an ISA because their employer makes a monthly contribution to their pension. For many people, this may be into a bog standard personal pension, but a number of employers will happily pay the money into a SIPP instead. As such, contributing 5% of your salary, for example, may be matched by your employer, which clearly gives SIPPs a major advantage over ISAs, into which employers will not make a direct contribution.
Flexibility
However, where ISAs have a major advantage over SIPPs is with regards to their flexibility. That’s because the money in an ISA can be withdrawn at any time to be used to buy a house, car, or for anything else you decide. This can be extremely useful – especially for younger people or individuals with less secure employment situations. SIPPs, meanwhile, cannot be drawn on until you are 55 (57 from 2028) and, looking ahead, this figure could realistically rise as the government seeks to tighten up the rules on SIPPs.
Rule Changes
In fact, the rules on pensions change so frequently that it is nigh on impossible to accurately predict which one will be the most effective way to invest over the long term. For example, in the last parliament alone, the present government has more than doubled the annual ISA allowance and at the same time has shrunk the amount that can be paid into SIPPs each year. During the next parliament and beyond there will inevitably be a number of other changes, which makes having both a SIPP and an ISA the most logical and prudent option.
Certainly, one may prove to be better than the other in your lifetime but, at the present time, that remains a known unknown. As such, having one of each makes sense for most people.