SIPP, ISA or Both?

[fca2019]

For those currently saving, do you invest in a SIPP, ISA or both?

What do you do/recommend, and why?

I have for the past 2 years favoured an investment ISA, but more recently decided SIPP might be better.

I've crunched some numbers and this is my thinking... if the logic sound...

Example - save £20k p.a., interest rate of 5% p.a., save for 10 years, retire, then drawdown for 10 years. Assume BR tax.
(Using compound interest calculator for years 0-10, and an amortisation calculator for years 10-20).

ISA
At end of year 10 accumulated balance = £259,882.67. Saving £1,667.67 p.m.
Drawdown years 10-20 £2,756.46 p.m. (£330,775.04 over 120 payments).

SIPP
At end of year 10 accumulated balance = £324,852.17. Saving £1,667.67 p.m. + tax relief £416.66 p.m..
Lump sum £25% = £81,213 + Taxable at 20% = £194,911 - over 10 years.
Drawdown years 10-20 £2,928.73.73 p.m. (£351,447.19 over 120 payments).

So in this example, I would be benefiting £172.27 p.m. by investing in a SIPP than an ISA.

I'm thinking the biggest drawback of this plan is tying funds up, and at risk of a future government either putting back the date at which you can access the SIPP from 55 to 57, to 60, and the tax free lump sum could also be removed by a future government.

[JohnB]

Your analysis is correct. SIPPs have Inheritance Tax advantages too

[TedSwippet]

I'm thinking the biggest drawback of this plan is tying funds up, and at risk of a future government either putting back the date at which you can access the SIPP from 55 to 57, to 60, and the tax free lump sum could also be removed by a future government.

As mentioned already, you're right that SIPPs give a better tax result. The simple reason for this is that you are trading what looks to be a 20% tax rate now for an effective 15% tax rate (20% tax on 75% of a withdrawal, so allowing for PCLS) in future, or even lower if this lets you use future tax-free income allowances in drawdown that might otherwise be lost.

Reward comes from risk, though. So yes, all of what you mention above. The government has already said that they intend to move the SIPP access age to 57 by 2028. If you were to hold the same investments in a SIPP and ISA, the market (and inflation) risk would be the same in both. The political risk in a SIPP is higher.

[Alaric]

The political risk in a SIPP is higher.

There is also the risk that if the investments have done really well, or you just needed a lot of money over a short time period, that you pay higher rate tax on the withdrawal. Costs charged by platforms for running ISAs are generally lower than they would charge for a SIPP.

[Darka]

I would go for both.

I have several ISA's which will provide the bulk of our retirement income, with my SIPP kicking in a few years later on which will add a nice level of additional income.

The main benefit for me using the SIPP, is that I can salary sacrifice and get back some of the National Insurance I would have paid, and additionally I get a 12% contribution from my employer which I would not get without the pension. (Note that I don't get this contribution into my SIPP, it goes into a Private Pension which will be transferred to my SIPP on retirement).

So, with 12% from them and 14% from me, I generally put 26% of salary into my Pension, and eventually into the SIPP.

As for the ISA's I put aound 50% of take home pay into those.

[TUK020]

Big benefit (a) of SIPP contributions is if you can arbitrage your rates of tax while earning vs while retired.
If you are a higher rate taxpayer now, and are likely to be a basic rate taxpayer as a pensioner, then this works in your favour.
If you are in the band £100-123k, then your marginal rate of tax is 60% as allowances are removed. Anything you earn in this band ought to be going into SIPP to keep your taxable earnings under 100k.
If you are Basic rate now, then this becomes less compelling, and the flexibility of ISAs is worth considering. All pensions suffer from government propensity to bugger around with the goalposts.

Benefit (b) is that your pension assets can be passed (if you die under age 75) to heirs outside of your estate, and thus avoiding IHT.

[vrdiver]

I'd also recommend using both.

SIPP for the tax and IHT benefits, ISA for the flexibility and access.

Your actual decision will be personal to you: what tax rate are you paying / do you expect to pay in retirement? Do you want to retire before 55/57/60 or whatever age SIPP access is available when you get there? Can you keep your hands off your ISA (some people really can't).

The other question worth asking, if you have a partner, is whether you trust them with your finances? The tax situation may make paying into their SIPP more interesting than paying into yours? For a non taxpaying partner you can pay in £2880 each year and get the £720 uplift from HMRC, which isn't a bad bonus, as well as them probably being able to access it tax free on the way out.

I retired at 50 and used the ISA investments as my pension (running down some of the ISA capital as I couldn't draw down the SIPP dividends, but invested them instead, so the effect waas to transfer capital from my ISA to my SIPP, vs being able to just draw dividends from both of them).

Having both gives you a bit more flexibility currently, and may lessen the impact of any future government meddling.

VRD

[fca2019]

The simple reason for this is that you are trading what looks to be a 20% tax rate now for an effective 15% tax rate (20% tax on 75% of a withdrawal, so allowing for PCLS) in future, or even lower if this lets you use future tax-free income allowances in drawdown that might otherwise be lost.

Thanks everyone for explanations. Helps clarify my thinking. I'm just in the higher rate tax band, so would be trading 40/20% tax rate now for effective 15% or lower in future. Think I should increase the proportion of saving in my SIPP.

[fca2019]

Benefit (b) is that your pension assets can be passed (if you die under age 75) to heirs outside of your estate, and thus avoiding IHT.

I believe all pension assets are outside of IHT. The difference being if you die before 75 the asset can be drawndown by your beneficiaries free of income tax, whereas over 75 will be taxed at the beneficiaries marginal rate of income tax. Thank you George Osbourne. I take an interest in this area as named as a beneficiary of some of my parent's pension.

[tikunetih]

Point of order: title should be "Pension, ISA or Both?".

SIPP is just one type of personal pension, and other options are available and may suit the individual, depending on circumstances.

Re tax arbitrage, my partner has managed to make essentially all her contributions to one personal pension at 40% and should draw virtually all of it down within the personal allowance. Big benefits there.

So long as you are sensible and not obsessive about the tax tail wagging the dog to the exclusion of all else, for a majority of people investing should probably be focused initially and predominantly on making full use of pension wrappers.

[kempiejon]

So long as you are sensible and not obsessive about the tax tail wagging the dog to the exclusion of all else, for a majority of people investing should probably be focused initially and predominantly on making full use of pension wrappers.

tikunetih, I agree that the pension is a handy wrapper and tax can be manipulated as you mention but circumstances will play a part too. 20 odd years ago when I started investing I didn't like the restrictions placed on pension pots nor their vulnerability to the government whim. I hoped to retire early too so used ISAs to the full and invested the balance in unsheltered accounts as prevailing tax allowances for income were suitable for my needs. I do acknowledge that the landscape has changed today, even so those investors with a decade or more until access to the SIPP (currently at 55) with a plan for earlier retirement could benefit in salting as much cash away from the tax man via an ISA first. As I said this was my early plan, I maxed the ISA and made personal and company contribution from employment, nearer to 55 I can focus more on the SIPP. I too look to leverage the tax differential between contribution and drawdown.

[Dod101]

Those with shorter memories than mine will know that the rules governing SIPPs can and have been manipulated on a regular basis by successive governments. We have had a period of relative stability in recent years with SIPPs but there was a while when they seemed to change almost with every budget. That contrasts with ISAs where more or less the opposite has happened and they are so very flexible that I would concentrate on them.

I hold a biggish ISA split between two providers, and one SIPP. The SIPP is not very big and yet costs far more to run than the ISAs. Obviously tax will come into the thinking but I pay very little tax anyway, and that is usually more or less my choice, because any significant tax arises through CGT from the sale of certificated holdings.

I think your answer has to be to hold both, and make sure that you fill your ISA allowance each year.

Dod

[Urbandreamer]

Thanks everyone for explanations. Helps clarify my thinking. I'm just in the higher rate tax band, so would be trading 40/20% tax rate now for effective 15% or lower in future. Think I should increase the proportion of saving in my SIPP.

I would be, were it not for my pension. Ignoring for a moment the investment case for SIPP or ISA, pension contributions can make a large difference to how the state or state institutions relate to you.

For example pension contributions can ensure that Child allowance is not reduced (this wouldn't affect me but will others).
When applying for a student loan, household income is taken into account, but pension contributions are subtracted.
The dividend and interest allowances are halved, for those who fail to manipulate their taxable income. Quite litterally you could end up with a £1 rise in income costing you houndreds of pounds.

I'm sure that there are other implications.

[jonesa1]

To me the advantages of a pension (SIPP or otherwise) outweigh the advantages of an ISA if:
1) you can contribute at 40% marginal tax rate and withdraw at 20% or zero, or
2) you can contribute at 20% and withdraw at zero, or
3) you're getting an employer contribution (effectively deferred pay), or
4) you have particular circumstances where it is significantly beneficial to reduce your taxable income (examples mentioned in a previous post by Urbandreamer), or
5) you need to lock the money away where it can't be accessed (maybe you doubt your own self-discipline, or fear pressure from others to "help out" if they know you have accessible wealth)

Otherwise, the financial gain from the pension wrapper is not huge and needs to be set against the greater flexibility of an ISA. The political risk exists for both wrappers and it's impossible to know what changes lie ahead.

[vrdiver]

One other thing to consider with pensions is the LifeTime Allowance - LTA.

If you are in the happy position of being able to save/invest this much in your pension, the taxman will start to claw back the tax relief you thought was yours. For some, it may be another reason to divert (some) retirement funds away from pensions.

The LTA level has been a political football (introduced, increased, decreased etc) and a cash-strapped chancellor may well take another look at it, or even abolish it if that would cement votes (if you will entertain such a cynical thought...). It is a bit of a wildcard in pension planning, as above-expected returns on your investments may be penalised by this.

VRD

[Alaric]

The LTA level has been a political football (introduced, increased, decreased etc) and a cash-strapped chancellor may well take another look at it, or even abolish it if that would cement votes (if you will entertain such a cynical thought...).

It would be far simpler for future contributions to just cap the annual amount that can be put in, as for ISAs. Some formula of equivalence would need to be established for defined benefit schemes. As they get closed down, it becomes a problem increasingly confined to the public sector. It might even be better to take defined benefit schemes out of the contributions regime entirely and revert to setting limits for the benefits. Your total P60 salary is in principle known for each tax year of your working lifetime, restrict the defined pension benefit to a percent of that, perhaps with an enhancement for short service.