ISA vs SIPP – Which is Better?

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THINK

“In this world nothing can be said to be certain, except death and taxes.”
Benjamin Franklin

You’ve watched my video, “The FASTEST Way to Destroy Debt (58 Tips)”…

You’ve eliminated your debt and got some savings…

You’re finally ready to take the plunge into investing…

We’re just 5 days away from the end of the financial year…

But you don’t know whether to put your money into a Stocks & Shares Individual Savings Account (ISA) or a Self-Invested Personal Pension (SIPP)?

The UK have one of the most generous tax-incentivised accounts for individuals in the world.

You can invest up to £20,000 /year in an ISA (soon to be extended by £5,000 with the British ISA) and £60,000 /year in a SIPP.

Most people don’t have £80,000 knocking about, so they have to decide on one over the other.

But which is best???

Fear not, my friend. I’m here to walk you through the Pros and Cons of each option to help you decide which is best for you.

The SIPP

The SIPP is a Self-Invested Personal Pension. You control what you invest in, and you can buy a range of different assets, such as stocks, bonds, commodities and commercial property.

For most people, sticking to a simple low-cost global index fund will be more than sufficient. (Watch my ‘Investing for Beginners’ video for more).

You can access your investment pot money from age 55, which will increase to 57 in 2028. There’s every possibility that this will continue to increase over time.

When you reach 55 (or 57 in 2028), you can take up to 25% of your pension fund tax-free (up to a limit of £268,275).

You then pay tax on the remaining amount, based on your income tax bracket in retirement.

When you reach retirement age, you have options. You can take lump sums, draw an income, buy an annuity (guaranteed income for life) or leave your SIPP invested.

You’re the captain of your financial destiny.

The Pros of a SIPP

No Tax Within – Any income or capital gains you get from investments within your SIPP are tax-free. (Same as an ISA)
25% Tax-free Lump Sum – When you hit retirement age, you can withdraw up to 25% of your pot tax-free (capped at £268,275).
Inheritance Tax – One distinct advantage of a SIPP over the ISA is that death benefits are not subject to inheritance tax. If you die before the age of 75, there is no tax liability. The SIPP benefits transfer to your nominated beneficiary (spouse, partner or child) as either a lump sum or an ongoing fund.
Carry Forward Contributions – You can carry forward unused pension allowances from the previous three tax years (not an option with an ISA):
- 24/25 = £60,000
- 23/24 = £60,000
- 22/23 = £40,000
- Maximum carry forward from 6 April 2024 = £160,000
Tax Relief – The SIPP’s biggest benefit over an ISA is tax relief… and it’s substantial!

The Government tops up any money you pay into your SIPP by 20%, and higher and additional-rate taxpayers can claim back a further 20% and 25%, respectively, via the self-assessment process.

Let’s take a look at 3 tax band examples to demonstrate the benefit:

Basic-Rate Taxpayer

If you’re a basic-rate taxpayer (earning <£50,270 /year), the government will add 20% tax relief, which equates to 25% of your contribution.

Basic-rate example:

You pay £8,000 into your SIPP.
The government adds £2,000 to the pot (25% of £8k).
If the stock market returns 10% /year, that’s 2.5 years’ worth of returns… for free!

The £2,000 government contribution can be invested into a global index fund, which will grow and compound over time.

Higher-Rate Taxpayer

If you’re a higher-rate taxpayer (earning £50,271-£125,140 /year), the government will add 20% tax relief. You can claim an additional 20% through your self-assessment, which equates to 50% of your contribution.

Higher-rate example:

You pay £8,000 into your SIPP.
The government adds £2,000 to your pot (25% of £8k).
And you can claim an additional £2,000 tax relief through your self-assessment (25% of your £8k)
In total, you receive £4,000 of tax relief on your £8,000 personal contribution (50%!)
If the stock market returns 10% /year, that’s 5 years’ worth of returns… for free!
Where else could you get 50% guaranteed annual returns? (HINT: You can’t).

If you’re a higher-rate taxpayer, you’re leaving a substantial amount of money on the table by not utilising your SIPP allowance.

There are even more benefits to being a higher-rate taxpayer, which I will cover shortly.

Additional-Rate Taxpayer

If you’re an additional-rate taxpayer (earning >£125,141 /year), the government will add 20% tax relief. You can claim an additional 25% through your self-assessment, which equates to 56% of your contribution.

Higher-rate example:

You pay £8,000 into your SIPP.
The government adds £2,000 to your pot (25% of £8k).
And you can claim an additional £2,500 tax relief through your self-assessment (31% of your £8k)
In total, you receive £4,500 of tax relief on your £8,000 personal contribution (56%!)
If the stock market returns 10% /year, that’s 5.5 years’ worth of returns… for free!

Those in the higher-rate and additional-rate tax brackets have the biggest opportunity to save tax.

But they also have the biggest drawbacks, which many people fall into unknowingly…

The 60% Tax bracket

You can earn up to £12,570 tax-free in the UK. This is known as the Personal Allowance.

Once you earn more than £100,000, the £12,570 Personal Allowance tapers down at a rate of £1 for every £2 you earn above £100,000, increasing your tax burden.

If you earn £100,000, you’re taxed at 40%.

If you earn between £100,000 and £125,140, you’re taxed at 60% for any income above £100k.

So, for every £1,000 of income you earn between £100,000 and £125,140, you only get to keep £400 of it. 😲

Once you’re earning more than £125,140 /year, you don’t get any Personal Allowance.

But the SIPP can help…

Avoiding the 60% Tax bracket

If you’re in this bracket, fear not. You can regain some or all of the Personal Allowance, as well as benefit from additional tax relief by utilising a SIPP.

As long as you earn less than £260,000 /year, you can pay up to the annual contribution limit of £60,000 and reduce your tax burden.

Let me walk you through an example:

You earn £125,140 a year. You’ve lost all your Personal Allowance, and you’re paying 60% tax on £25,140.
You make a pension contribution of £20,112. The government will apply the 20% tax relief of £5,028, bringing your total pension contribution to £25,140.
HMRC will not consider the £25,140 total pension contribution as part of your taxable income. Your taxable income will be adjusted down to £100,000 (40%).
- You benefit from £5,028 (20%) being added to your pension from tax relief.
- You save an additional £5,028 in higher-rate tax by reclaiming your Personal Allowance. Meaning you can once again earn £12,570 tax-free.
- You can also reclaim another £5,028 (20%) on your tax return via your self-assessment.
By making a £20,112 pension contribution, your total combined benefit is £15,084 (75% return on investment). See below:

Lowering Your Tax Bracket

Any income you receive above £50,270 is taxed at 40%.

From 6th April 2024, employees pay 8% Class 1 National Insurance on earnings over £12,570 and 2% on earnings over £50,270.

NOTE: NI is calculated monthly (if you’re paid monthly), you could end up paying more on irregular income like bonuses.

If you earn more than £50,270, you can make pension contributions to benefit from tax relief AND reduce your tax and National Insurance liability.

Here’s how:

STEP 1 – Maximise Employer Contributions to Workplace Pension

Many employers will increase or even match your workplace pension contributions.

For example:

You contribute 3%, and they contribute 3%.
You contribute 5%, and they contribute 5%.

They will have a cap on what they’ll match. For example, they might only match up to 5% of your contributions.

Meaning, if you contribute 5%, they’ll contribute 5%. But if you contribute 10%, they’ll only contribute 5%.

Make sure you maximise the additional free money your employer offers.

STEP 2 – Increase Contributions to Your Workplace Pension

Once you’ve maximised your employer’s free contributions, consider increasing your contributions once more via ‘salary sacrifice’ to further reduce your tax liability.

For example:

If you earn £60,270, you could contribute £10,000 to your workplace pension pre-tax and receive £50,270.
You won’t have to pay 40% tax and the extra 2% National Insurance on the £10,000.
It’s also in your employer’s interest to do this because it will save them money by reducing their Employer National Insurance contributions and Corporation Tax. (Some employers will consider passing on that saving or splitting it with you)
Win-Win!

STEP 3 – Increase Personal Contributions to your SIPP

If you don’t have a workplace pension or your employer doesn’t offer a ‘salary sacrifice’, you take the £60,270 salary and make a £10,000 gross SIPP contribution.

For example:

You earn £60,270. You pay tax and National Insurance on that amount.
You make a gross contribution of £10,000 to your SIPP, which means your income falls into the basic rate tax band.
- £2,000 tax relief added to your SIPP
- £2,000 tax relief claimed via your self-assessment.
- For a personal contribution of £6,000, you make a gross contribution of £10,000.

There are a couple of downsides to this approach which are worth considering:

You get 40% tax relief (woohoo!), but you won’t get the additional 2% National Insurance that was paid (boo!).
When applying for a mortgage, the lender will consider your post-tax income only, not the £10,000 you pay into your SIPP.

The Cons of a SIPP

The SIPP carries multiple benefits over the ISA, but it has two main drawbacks.

Access – You can’t access your SIPP until you’re 55, which is due to increase to 57 in 2028. This is likely to continue increasing over time. The thought of having your money locked up for 20-40 years can deter people from starting.
Tax on Withdrawal – You can withdraw up to 25% of your pot tax-free (capped at £268,275), but you’ll be taxed on the remaining 75% at your income level.
Contribution Limitations Upon Withdrawal – Once you take your first taxable income from your SIPP, the amount you can pay into it moving forward is limited to £10,000 each tax year. This is called the Money Purchase Annual Allowance (MPAA). Taking tax-free cash (25% of your pot) alone won’t affect this.

The ISA

An ISA is an Individual Savings Account.

There are currently 4 types of ISA (soon to be 5 with the ‘British ISA’), including the Cash ISA, Stocks and Shares ISA, Lifetime ISA, and Innovative Finance ISA.

Cash ISA – Allows interest to be earned tax-free above the annual limit (£1,000 for basic-rate taxpayers and £500 for higher-rate taxpayers).
Stocks & Shares ISA – This is the one I will focus on for the SIPP comparison. All capital gains and investment income are tax-free. You could withdraw your entire pot and not pay a penny in tax.
Innovative Finance ISA – Allows you to invest in Peer to Peer lending. Like the two options above, all investment income is free from tax.
Lifetime ISA – This option is designed to help people under the age of 40 save for their first home or retirement. You can invest up to £20,000 on each of the options above, but the Lifetime ISA (LISA) is limited to £4,000 /year. The Government will add 25p for every pound you invest. So, with a £4,000 contribution, the Government will add £1,000. This is a great product, but there are a few restrictions to be aware of:
- You can only open a LISA if you are between the ages of 18 and 40.
- You cannot pay into a LISA after you turn 50, although you can still allow your money to accrue interest.
- You can only use the savings pot to buy your first home or use it for retirement from the age of 60 or if you are terminally ill. Otherwise, it’s locked up.
- You will be charged 25% of what you take out if you withdraw your money early. This means you would get less than you had initially put in if you accessed your money early.
- The property you purchase with LISA savings must cost under £450,000 and must be bought with a mortgage. You also must not own a property already.
- The LISA counts towards the £20,000 a year ISA limit.

If you’re between 18 and 40, the LISA is worth considering. Like SIPPs and workplace pensions, you want to maximise the opportunity when free money is offered to you. Sadly, I’m too old.

If I qualified for the LISA, I’d use the £4,000 allocation and invest the rest in a Stocks and Shares ISA.

Personally, I’m not interested in the Cash ISA or IF ISA. Here’s why:

Cash ISA – I invest in easy-access cash accounts instead because you don’t pay tax on the first £1,000 in interest as a basic-rate taxpayer. When rates were below 1%, it made no sense (£100,000 invested at 1% is tax-free anyway), and at 4-5%, it still requires a large amount of cash (£20,000-£25,000 invested at 5% or 4% respectively). Ultimately, I’d prefer to maximise the gains and income I make within a Stocks and Shares ISA instead.
IF ISA – Sadly, I’ve invested tens of thousands of pounds in Peer to Peer Lending in my time, and it’s been a huge disappointment. The appealing high interest rates end up being locked in or lost by the borrower. I still have 5 figures locked up in three separate platforms, which I’ve psychologically written off. Ultimately, this form of lending is far riskier than it appears. You can lose it all. I’d prefer to take my chances with the stock market.

For the rest of this post, I’m going to focus on the Stocks and Shares ISA.

In the Stocks and Shares ISA (and LISA), you can invest in a simple low-cost global index fund, just like a SIPP.

The size of your investment pot is unlimited, and you can access your money within a week.

The Stocks and Shares ISA is a wonderful complement to the SIPP. It has some advantages and some disadvantages, so let’s examine each.

The Pros of an ISA

There are 3 main benefits to an ISA over a SIPP, and the first 2 are substantial:

Access – You can access your cash whenever you like. This is HUWGE! If you want to retire before 55 or 57 (in 2028), the Stocks and Shares ISA can help you with that, either in entirety or to supplement your retirement until your SIPP, workplace pension or state pension kicks in. I built up a multiple 6-figure portfolio in my Stocks and Shares ISA. I withdrew virtually all of it to supplement a property development, which I felt had greater earning potential. When I sold my shares, it took a few days to settle the trades and a few days to withdraw the money into my bank. The whole process took about a week. I don’t recommend interrupting compound interest and withdrawing money from your ISA unnecessarily, but it’s reassuring to know that it’s possible.
No Tax on Withdrawal – All capital gains and investment income within an ISA are tax-free, as are any and all withdrawals. So, if you build up your ISA over time to your Financial Freedom number (annual expenses x 25), you could withdraw 4% of your pot every year without paying a penny of tax. Even if you have a taxable income.
- For example, if you contributed £20,000 /year for 25 years and received 10% returns, you’d have a portfolio worth £2,163,635.
  - You could withdraw £86,545 /year (4%) without paying any tax.
Continued Contributions – You can pay £20,000 /year into an ISA, which is due to be increased by an additional £5,000 for a ‘British ISA’. Once you start drawing on your ISA, you can continue to contribute to it if you wish.

The Cons of an ISA

However, there are drawbacks to an ISA when compared to a SIPP:

No Tax-Relief – A Stocks and Shares ISA will not benefit from any tax relief. (No free money)
Limited Contributions – You can contribute £20,000 /year in total across all ISA options. This is 1/3 of what you can contribute to a SIPP (£60,000 /year).
No Carry Forward – Unlike the SIPP, if you don’t use your £20,000 entitlement within a tax year, you lose it.
Subject to Inheritance Tax – ISAs are subject to inheritance tax. Your spouse can inherit your ISA pot, but if you don’t have a spouse or you hate them, it’s worth knowing.

Should You Invest in a SIPP or ISA?

In an ideal world, you’d fill both allocations every year. But most people don’t have £80,000 knocking about.

So, which one should you invest in?

Mathematically speaking, the tax relief you get from an SIPP (and LISA) would leave you with marginally more money.

But there’s more to life than money…

Early Retirement (<55) is only possible with a Stocks and Shares ISA.

Some would also prefer to have the option to draw their ISA money for a house deposit, property investment, or their child’s University fees.

Take my situation for example:

My property investment business will eventually provide me with the full basic-rate tax wage for the remainder of my life (£50,270 /year). It essentially acts like a pension, but I can draw from now. This income will be taxed at a basic-rate (20%).
Any income I draw from my SIPP will move me into the higher-rate threshold and be taxed at 40%. Unless I reduce my drawings from the property investing business (I will likely do this).
On the other hand, any income I draw from my Stocks and Shares ISA will have zero impact on the amount of tax I pay. All my ISA drawings are free from tax.
I don’t have kids, so I’m less concerned about the Inheritance Tax consequences of an ISA.
Therefore, my priority is to fill the £20,000 over the SIPP, although I invest in both.

There is no one right answer. You must decide which benefits appeal most to you.

If you’re in any doubt, invest in both. It doesn’t have to be one or the other.

You can always change your allocation percentage in time.

A Case for Both

It’s worth noting that the rules and regulations for each can change at any time.

Last year, the SIPP had a Lifetime Allowance of £1,073,100. It sounds like a lot of money (and it is), but if you were drawing 4% of your pot, it would only provide £43,000 /year. This isn’t a lot of money for a large family in a big city.

Thankfully, the Lifetime Allowance was abolished.

There were/are rumours that they’ll eventually cap the ISA. Some suggested it could be as low as £100,000. Meaning you would be subject to tax on any amounts above this.

They might reinstate the Lifetime Allowance for the SIPP or introduce one for the ISA. They might decrease what you can contribute to each or increase one of them. They could even introduce a new tax band for income taken from an ISA. They might increase the withdrawal age for a SIPP to 60 or 70…

Who knows what the government will do?!

If I only invested in an ISA, with the goal of creating a MEGA tax-free income early retirement, and then they introduced a £100k tax cap, I would be kicking myself for not investing in a SIPP.
Likewise, if I only invested in a SIPP and they reinstated a Lifetime cap or pushed the withdrawal age to 70, I’d regret not utilising an ISA.

Don’t waste your energy trying to guess the Government’s next move.

Create a diversified plan which isn’t reliant on either.

Combining an ISA and SIPP in Retirement

The full State Pension will increase to £11,502 /year from 6th April 2024.

The State Pension age is currently at 66 years old for both men and women. It’s set to rise to 67 between 2026 and 2028.

If you’re in your 20s-40s, there’s every chance the landscape will change by the time you hit the traditional “retirement age”.

If you want to retire earlier than 67, you can utilise your ISA and SIPP before you’re entitled to the State Pension.

Eg. You want to live on £30,000 /year.

If you are under 55 (or 57 in 2028), you could draw £30,000 /year from your ISA and allow your SIPP to continue compounding. However, if you have no additional income (from property or part-time work), you’re missing out on your tax-free Personal Allowance, which is currently £12,570 /year.
If you’re 55 (or 57 in 2028), you could withdraw £16,760 /year from your SIPP tax-free. 25% of SIPP withdrawal is tax-free (£4,190). The remaining 75% (£12,270) is taxable, which coincidentally matches your Personal Allowance, meaning you won’t have to pay any tax. You can use your ISA to make up the difference and draw £17,430, again tax-free.
- Live on £40,000 /year = Withdraw £27,430 /year from your ISA
- Live on £50,000 /year = Withdraw £37,430 /year from your ISA

I don’t give financial advice. Everyone’s circumstances and goals are different.

If you’re STILL unsure of which tax vehicle to invest in, you could split your investment allocation 50:50 (SIPP:ISA) for now, keep your eyes on government changes and adjust accordingly in time.

I think it’s more important to underscore…

Are you maximising your annual allowances of each?

If not, how could you contribute more?

Reflect and share this with someone.

ASK

“Are you maximising your annual SIPP and ISA allowances?”

“What could you do to contribute more?”

Write down what comes to mind.

TRY

Another meaty topic this week. Congratulations if you made it this far! 👏

You have until 5 April 2024 to utilise your SIPP and ISA allowance.

Granted, you can ‘carry forward’ the SIPP contribution to next year, but if you don’t fill your ISA allocation, it’s gone.

Do you have a SIPP or ISA?

Is there anything you can do to put more into them this year?

If you’re a higher-rate or additional-rate taxpayer, self employed or a director in a limited company, it’s worth your time looking into opening a SIPP, and contributing what you can.

If you’re below the age of 40, look into the LISA and do what you can to fill that every year.

Don’t rely solely on one tax-efficient vehicle. The rules can always change in the future.

Take a diversified approach and utilise the LISA, Stocks and Shares ISA and SIPP to give yourself more financial flexibility.

Today’s topic was dense and it’s likely you have several questions.

As always…

HIT REPLY and ask away. I’ll do my best to help.

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Remember: Little by little, a little becomes a lot.

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