SIPP vs ISA: Which is Best For You?

Both have their tax perks. But how do you pick between the two?

WORDS BY
Zoe Burt
Published
January 19, 2024
Both have tax benefits and both allow you to invest, provided that you live and pay taxes in the UK (Image: Female Invest)
Tags
Personal Finance
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Staying on track when investing can be tricky – we get it. Thankfully in the UK, we have a fair few tools to help us out, amongst them being the SIPP and the ISA. Both have tax benefits and both allow you to invest, provided that you live and pay taxes in the UK. 

It’s not all rainbows and butterflies though, as they both have limits and restrictions that can inform your decision on which one you choose. But in fact, it’s not an exclusive situation and the truth is, you can live in harmony with both of them in your life. 

Before we get ahead of ourselves, let’s take a look at the key pros and cons of each of them, before we decide which one to choose.

SIPPs

We’re starting with the SIPP, which stands for Self-Invested Personal Pension. As the clue is in the name, the SIPP is a great tool to help save for retirement. This means that it offers the same tax benefits as other pensions you might have, like an employer pension.

Taxation on a SIPP

When you make contributions to the SIPP, you will automatically receive 20% tax back from the government, which will increase your contribution by 20%. So if you want £100 to go into your SIPP, you only really need to contribute £80, because the government will top up the remaining £20 with the tax back. 

SIPPs can also be used as a vehicle for pulling together old pensions from previous workplaces (Keren Levan/Unsplash)

If you’re a higher or additional rate taxpayer (that means you’re earning over £50,000 per year), you can also claim back the additional 40% or 45% tax that you’ll be paying. However this requires an extra bit of legwork and you have to reclaim the money yourself, usually via self assessment.

NOTE! This is up to a maximum limit of £240,000, so if you’re close to this limit, you might need further, more technical advice.

SIPPs can also be used as a vehicle for pulling together old pensions from previous workplaces. As many of us will end up working in multiple jobs with different companies, it’s not difficult to acquire four or five different pension pots. 


Keeping track of SIPPs

Keeping track of these is no easy feat and the estimated amount of missing and lost pensions out there is in the millions. Many providers offer to help trace pensions that you might’ve lost track of, and also contact old pension providers to get them combined into one pot. Having all your pensions in one place can help reduce admin and make sure that you don’t lose any precious retirement contributions. The movement of pensions is also tax free, even if you’re under the age where you can access them. 

As the name might suggest, a SIPP allows you to choose your own investments. This is usually a combination of stocks, funds and ETFs, depending on what the SIPP provider has available. The money that you then save into the pension has the chance to grow free from income, dividend and capital gains tax. This lasts for the entire time that you have the SIPP, which means that your savings and investments towards your pension can really bloom, without the burdens of taxation.

Maximum contributions to a SIPP

There are a few limits to be aware of when thinking about investing into a SIPP. As it is a pension, currently you are unable to withdraw your money until the age of 55, which will be rising to 57 from 2028. At this point, you can typically take 25% tax-free cash and the remaining payments will be taxed as income. The SIPP is therefore tax free on the way in, tax free whilst it's growing and then mostly taxable on withdrawal. 

ISAs and SIPPs can live in harmony with one another. Consider both.


There is also a limit to how much you can put in with tax benefits each year. Currently you can contribute a maximum of £40,000, or the entire amount that you’ve earnt in a year, to your pension. For self-employed individuals, this can be a vital way to save towards your pension as you won’t have an employer pension like others who are on a payroll. Those who do have an employer pension can also use a SIPP to make extra pension contributions, as long as you’re within those annual limits. You can choose to contribute above the annual limit, but there will no longer be tax benefits and you therefore might face a hefty bill, which isn’t on everyone’s agenda! 

Pros and cons of SIPPs

So, to summarise, there are some key pros and cons of SIPPs that it’s worth being aware of. As we aim to be positive here at Female Invest, we like to start with the pros of SIPPs.

Pros

  • Tax free growth on investments whilst money is in the SIPP
  • Tax benefits on contributing to a SIPP
  • Ability to combine old pensions to reduce administration into one pension
  • Greater freedom to choose investments, like funds, stocks and ETFs
  • Disciplined savings for those who need to have large sums of money like pensions locked away
  • Large annual limits on contributions (up to £60,000 or total earnings)

Cons

  • Investments have to be handled by you, or sometimes a financial adviser, which may cost time and money
  • You may be taxed at your marginal income rate when you start withdrawing from your SIPP.
  • You cannot withdraw any funds from the SIPP until the age of 55 (or 57 by 2028) as it is in a pension structure
  • It’s unlikely that your employer will contribute to your SIPP so you may still have to maintain two pensions whilst employed

There are four main types to be aware of, the Cash ISA, the Stocks and Shares ISA, the Innovative Finance ISA and the Lifetime ISA (LISA) (Image: Female Invest)

ISAs

Okay, so moving onto ISAs. ISAs are another tax-efficient way to invest your money. There are four main types to be aware of, the Cash ISA, the Stocks and Shares ISA, the Innovative Finance ISA and the Lifetime ISA (LISA). ISAs are great because there is no tax to pay on any growth whilst money is invested, much like a SIPP. Let’s take a look at how it works. 

Taxation on an ISA

When money is in an ISA, and we mean any of the types listed above, there is no tax to pay. This means that investments are free from capital gains and dividends taxes and any cash is also free from income tax on the interest earnt. There is also no tax on withdrawing money from the ISA, so you can do this freely as and when you want without thinking about potential income tax. 

Unlike a SIPP, there are no tax benefits on the way in. Any contributions you make will likely have come from your salary or earnings, which have already been taxed. So there’s no need to tax you twice.

Maximum contributions to an ISA

Currently, you can contribute up to £20,000 in total, across all your ISAs each tax year. At the moment the tax year runs from the 6th April, which is when everyone’s ISA limit resets. If you don’t use your £20,000 for the year, it’s lost. It is important to note that within this limit you can only pay into one type of ISA in each tax year. The Lifetime ISA also has a maximum limit of £4000, which falls under the total umbrella of £20,000. For example, if you pay the maximum amount into your LISA, then you will have £16,000 remaining to pay into other ISAs. 

With the cash, stocks and shares and innovative finance ISAs, there are no restrictions on when you can and can’t withdraw. If you want to change providers though and decide to withdraw your savings, the £20,000 limit stands. For example, if you’ve got £50,000 saved in a stocks and shares ISA and withdraw that amount to be able to add it to a different stocks and shares ISA, you still only have the annual £20,000 that you can contribute to ISAs. If you use all of the full limit you will have £30,000 left over that you withdrew from the ISA and you can’t add into an ISA in that tax year. The easy way to avoid this problem is to transfer any ISA that you want to move, rather than withdrawing and contributing again.

Then there's LISAs, where you can save up to £4,000 a year towards your first home or retirement (Image: Female Invest)


Lifetime ISAs (LISAs)

An important type of ISA to note is a LISA (Lifetime ISA) which can be opened by anyone aged between 18 and 39. You can save up to £4,000 a year towards your first home or retirement and the government adds a cash bonus of up to 25% on top of what you save. However, with the LISA, the money has to be used to buy a property as a first time buyer, or for retirement with withdrawal after the age of 60, otherwise you will lose the 25% government bonus that is associated with the LISA. 

Last but not least, you must be a UK resident and taxpayer to open and contribute to an ISA. If you ever move away, you can keep hold of your ISA but you can’t keep contributing. 


Pros and Cons of ISAs

Once again, good news first. Let’s start with the pros of ISAs. And remember, each ISA is slightly different with it’s own properties.

Pros

  • Money grows free of dividend, capital gains and income tax whilst invested in an ISA
  • Money can be withdrawn tax free from ISAs
  • You can split your allowance of £20,000 between the ISA types in whichever you wish
  • You can withdraw from an ISA whenever you wish, as long as it isn’t a restricted type like the LISA
  • You can keep hold of your ISA if you ever leave the UK


Cons
  • There are no tax benefits on the contributions you make to an ISA
  • There is a maximum limit of £20,000 per year, across all ISA’s, which cannot be exceeded
  • If you don’t use your annual allowance of £20,000, it will be lost, you can’t roll it forward to use in other years nor can you donate it to others
  • You cannot contribute to more than one type of each ISA per tax year which means your provider options can be restricted
  • You can’t open nor contribute to an ISA if you’re not a UK resident and tax payer


Which one should I choose?

So now you know a bit about both the SIPP and the ISA, their key features and pros and cons. When trying to decide which is best for you, it’s worth understanding some of their key differences. The biggest difference between a SIPP and ISA is how you access your funds; on a SIPP it’s restricted until the age of 55 and then taxed, whereas an ISA is much more flexible. The one that works best therefore usually boils down to the goal that you want to achieve with your investments. If you are working towards long-term investing and saving for retirement, perhaps a SIPP is the answer. For short and medium-term goals, investing in an ISA is probably more appropriate for what you need.

(Photo: Lil Artsy/Unsplash)


Do you want to start saving for your retirement in a disciplined way and preparing to live your best life from age 60 onwards? If you’re self-employed and needing a pension structure, then a SIPP might be for you!

Do you want to invest, hopefully see some growth, but want to use the funds to pay for your youngest child to go to university? Then an ISA could be for you. And the good thing is, if your youngest decides university isn't for them, you can leave your funds invested!

So how do you set them up?

How to open a SIPP 

Firstly, you will need to pick a provider to open your SIPP. There are hundreds out there, each with different charges and investment selections available. Your budget and investing experience will affect which one is right for you. Once you’ve chosen your winning number, you will then need to apply online, by phone, or by post. The provider will then help you to either combine old pensions into the SIPP and/ or make additional contributions to your pension.


How to open an ISA

ISAs are available from banks, building societies, stockbrokers, platforms, and many other financial institutions.  There are also different types of ISAs to consider. You can choose between a Cash ISA, a Stocks & Shares ISA, an Innovative Finance ISA and a Lifetime ISA. Which one you choose will depend on your risk appetite, time horizon, and what you want to achieve with the ISA.

Once you have picked the provider you would like to go with, and the type of ISA, opening the ISA should be as simple as filling in a form, applying over the phone, or completing an online application. You will need some basic information, like your National Insurance number and proof of address. At this stage, you may also need to transfer the minimum amount required to open the ISA, if the provider has put this in place.


The bottom line

It’s now time to have a think about the various pros and cons of SIPPs and ISAs and what would suit you best. Your goals, your time frame and your needs are ultimately the most important factors influencing the decision. Consider these and work out whether a SIPP or an ISA would be apt for your financial situation. And remember, it’s not an exclusive thing – you do not have to choose between the two as you can use the two together in harmony.

 

Tags
Personal Finance

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