SIPPs versus ISAs
This handy guide explains the tax advantages and benefits between ISA’s and SIPP’s – both of them being efficient investment vehicles – but which is right for you?
Individual savings accounts (ISAs) and self-invested personal pensions (SIPPs) are both tax-efficient wrappers that can be used to save money for retirement.
ISAs can also be used to save money for a rainy day, as the money can be accessed anytime, whereas you cannot get your hands on the money in your SIPP until your 55th birthday.
Both SIPPs and ISAs offer a wider choice of investments and greater flexibility than your average pension, giving investors the opportunity to achieve better returns if they make the right choices.
However, there are some important differences between the two vehicles, which are set out below.
Tax reliefs
Normally, you pay income tax on income from your investments, and capital gains on any growth in the value of those assets. Both ISAs and SIPPs allow you to protect your savings and investments from these taxes.
However, SIPPs also offer a tax top-up when you pay money in, at the rate of 20 per cent, or 40 per cent for a higher-rate taxpayer. So if you save £800 into a SIPP, the government will generously top that up to £1,000 (essentially giving you back the 20 per cent tax you would have paid on the £1,000). Higher-rate taxpayers can claim back an additional £200 through a self-assessment form.
ISAs don’t give you this benefit, but they do have one tax advantage over SIPPs. You don’t have to pay tax on money you withdraw from your ISA, whereas the taxman treats income that comes out of a SIPP in the same way as any other income, except for a tax-free lump sum of up to 25 per cent of your entire SIPP pot that you can claim at 55.
It’s likely that for most investors, SIPPs will work out as more tax-efficient, especially for higher-rate taxpayers.
Returns
A cash ISA will give you an interest rate of around 3 per cent, based on current offerings. The return from a stocks and shares ISA will obviously depend on the wisdom of your investments.
The return from a SIPP will equally depend on your investment decisions, but don’t forget the impact of the tax top-up of 20 per cent. Every £800 you pay in will automatically turn into £1,000, which you could see as an instant 25 per cent return. Virtually no investor will make a gain like that from stockpicking.
Contributions
You can pay far more into SIPPs than ISAs. For 2012, the annual ISA allowance is £11,280. Savers can allocate up to £5,640 to a cash ISA, while the remainder can be placed into a stocks and shares ISA.
You can put up to £50,000 a year into your SIPP (or 100 per cent of your annual income, whichever is smaller). If you’re not a taxpayer, you can put in a maximum of £2,880 a year and still get the tax top-up of 20 per cent, giving you £3,600.
Access
ISAs can be used as an emergency fund, with savings not locked away for the long term and not taxed as they’re withdrawn. SIPPs cannot be accessed until you turn 55, although this can be an advantage if you don’t trust yourself to leave the money alone until you retire.
A balancing act
In very broad terms, the distinction to bear in mind is that SIPPs are more tax-efficient but ISAs let you get your money out in a rush.
Remember that you don’t have to choose between ISAs and SIPPs, though; you can have both. A mixture of saving through SIPPs and ISAs will be most appealing to the majority of investors. This should enable you to manage both your medium-term and long-term savings.
Source : What Investment