ISA Vs SIPP: Which Tax Wrapper Should I Use?

17th Mar '23 by Megan Boxall

12 comments 1883 reads

If you’re a British citizen over the age of 18, there is nothing to stop you from having both an ISA and a Sipp. Both are efficient wrappers to help your investments grow free of capital gains and dividend tax.

But which allowance should you use first? And are there other factors you should consider before setting up either account?

Absolutely. This article will compare the ISA and Sipp wrappers to help you make the best decision. Will be be covering:

The key differences between the Sipp and the ISA tax wrappers
Why long-term compounding has a greater impact in the Sipp
The restrictions on withdrawing money from your Sipp
Inheritance tax

What is a Stocks and Shares ISA?

An ISA is a tax-free savings account. Money saved within the ISA wrapper isn’t charged any tax on capital gains or dividends. All eligible ISA participants receive a £20,000 annual allowance. This renews at the end of each tax year on 5 April and you can’t roll your ISA allowance over into a new tax year. Use it, or lose it. For now, there is no upper limit for how much you can save in an ISA. The only restriction is your £20,000 annual allowance.

You can take the profits out of your ISA account at any time and you don’t pay any tax on the withdrawals.

What is a Sipp?

The Self Invested Personal Pension (Sipp) is a wrapper which allows you to save for your retirement free of capital gains and income tax. The Sipp allowance is part of your overall pension allowance - you can save the equivalent of 100% of your income in your pension (up to £60,000) every year. This allowance can be rolled over for three years.

When you contribute to your Sipp, the government will top up your contribution by 20% to compensate for the income tax you have already paid on that money. If you are a higher rate income tax payer, you can apply for additional tax relief.

Any money saved in your Sipp can be used to pay you an income in retirement. You can take 25% out as a tax free lump sum (up to a maximum of £268,250 -equivalent to 25% of the previous lifetime allowance) and then…

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stehuk

17th Mar '23

Maximum annual contribution of £2880 net isn't just if unemployed. It's more generally if earned income is £3,600 or less.

Also, an important point about pensions is that they don't count towards capital if ever there is a need to receive means tested state benefits. If investments are held in an ISA then any capital value over £6000 would lead to a reduction or elimination of the benefits in such circumstances. So SIPPs are superior in this respect.

ettrader

For flexibility you cannot beat an ISA as all withdrawals are tax free income at any point in your life. Whereas with a SIPP you have to be age 55 to take tax free withdrawals then a host of other restrictions get triggered which limit further investments into the fund at the most critical time in your life right before retirement (was £4000 per year tax free just been increased to £10000).

Example, you're 66 starting your retirement, if you mix and match you can have 250K ISA pot invested in high yielding stocks averaging 5% and your state pension giving you £22500 income per annum tax free (ISA dividend withdrawal and the state pension), you've still got another £2000 available from your 12K allowance. Now add on your pension pot going into draw down or an annuity you've got more retirement income for longer as you can withdraw less from the pot. With an ISA there isn't a time limit for tax free benefits for a SIPP the tax free benefit expires at age 75 so all income taken is now taxable.

brads13

18th Mar '23

Good summary of the current position. Two issues:

Pensions are basically a tax arbitrage. Tax relief when funds go in and taxed when withdrawing.

If a basic rate taxpayer 20% relief going in , and 15% (after 25% tax free) coming out.
Higher rate tax is 40% going in and if at retirement a basic rate taxpayer, 15% coming out.
Of course, one can get 60% when contributing if income between £100k and £125k.

When the article compares the compounding effect, it is comparing the ISA balance (no tax) with the SIPP pre-tax balance. The SIPP balance is 20% higher, which is the Govt tax relief going in, but hasn't/can't adjust for the tax coming out.

Political risk. Future tax rates are not guaranteed, nor is the 25% tax free lump sum. There is also no National Insurance on pensions, and as people over pension age pay lower taxes and receive a larger share of resources (health + state pensions) they will be seen as having broader shoulders (I hate that phrase) and become a target for future Chancellors.

The 25% tax free lump sum has been changed from a percentage to the lower of a fixed sum £268,250 and 25%. Watch that fixed sum be reduced or just eroded with inflation.

I also wouldn't be surprised if a pensions tax was introduced (like a dividend tax) at a lower percentage on those with pension income above £xpa. Unlikely? Just remember Insurance Premium Tax that started at 2.5% in 1994 and has been slowly increased and now is charged at two rates; 12% and 20%.

ISAs are not taxed so they are safer from future political meddling.

My view is you should reduce risk and have both ISAs and a SIPP.

fix9

Can anyone answer this ? I earn 50k as director of ltd company I pay myself 12k tax free allowance and live of this putting the remaining 38k directly into SIPP , does the government pay anything given I pay no tax ?

jsmajor84

What about the LISA?

You may not be able to contribute as much to a LISA but the 25% government bonus is... well a bonus! Obviously it has restrictions on withdrawals but it is another great option to take into consideration here.

Bigtim

20th Mar '23

If the company is contributing it then it is "net pay" meaning before tax is taken so no top up.

However, in the scenario above, the company makes a loss every year so also pays no corporation tax and could carry the loss forward for relief on future profits.

Rusty2

What about the options when you retire with a SIPP. Do most people do drawdown? Which SIPP providers are the best for that?

Rather than drawdown I'm planning to use uncrystallised pension lump sum once a year (£100 fee each time with Jarvis SIPP - drawdown costs more).

Vanguard don't charge anything for drawdown, but investment options are limited to Vanguard funds and Vanguard ETFs. As Vanguard charges are very low anyway this might be useful for some people.

dulciemo

I hope they don’t as you don’t pay any income tax.

I don't pay any income tax but the Govt. tops up my SIPP contribution.

If you only earn £12k, how can you put in £38k into a SIPP? Think you can only put in as much as you earn?

rmillaree

"If you only earn £12k, how can you put in £38k into a SIPP? Think you can only put in as much as you earn?"

If you have your own company the company can put in the excess even if your income is minimal

ISA vs SIPP: Which tax wrapper should I use?

What is a Stocks and Shares ISA?

What is a Sipp?

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About the Author

Megan Boxall

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