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ISA vs SIPP: Everything you need to know

When saving for the future, there are a variety of ways to do so in a tax-efficient way. Two of the most common ones are Individual Savings Accounts (ISAs) and self-invested personal pensions (SIPPs) but it can sometimes be hard to know which one is right for you.

While both ISAs and SIPPs enjoy favourable tax treatment, allowing you to build up your wealth in a tax-efficient manner, there is an important difference between them in how you access your funds. This is why it’s important to properly understand how each of them works before you decide to invest.

If you want to be able to make an informed decision when choosing between an ISA vs SIPP, read on for everything you need to know.

Also consider: My guide for ISA vs savings account

Key Takeaways

  • The main difference between an ISA and a SIPP is that ISAs are much more flexible, meaning you can access your money more easily.
  • ISAs are highly flexible, which can make them better for saving for short- and medium-term goals. Meanwhile, you can’t normally access your SIPP until you reach the age of 55 (or 57 from 2028).
  • You don’t have to pay tax on any interest or investment returns that you receive from an ISA.
  • Saving into a SIPP as a basic-rate taxpayer will see you receive tax relief of 20% from the government.
  • You can have both an ISA and a SIPP, so you don’t need to choose between them.
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Important information - investment value can go up or down and you could get back less than you invest. If you're in any doubt about the suitability of a Stocks & Shares ISA, you should seek independent financial advice. The tax treatment of this product depends on your individual circumstances and may change in future. If you are uncertain about the tax treatment of the product you should contact HMRC or seek independent tax advice.

What is an ISA?

An Individual Savings Account, or ISA, is a type of account that you can use to build your wealth in a tax-efficient manner. These tax wrappers can be great for growing your wealth in the medium and long term.

One of the main advantages of using an ISA is that they are typically very flexible, as you can usually take money out of them easily without having to pay any taxes or charges. This can make them ideal for a medium-term savings goal, such as buying a house.

ISAs are one of the most popular ways to save money, as you don’t have to pay Income Tax or Capital Gains Tax on any interest or investment returns that you receive. These tax savings can be useful for growing your wealth.

What types of ISA are available?

There are several types of ISAs on offer. Here are three of the main types of ISA that you may want to consider when saving for your goals.

Cash ISA

Cash ISAs are a popular way to save money and account for around three-quarters of all ISAs held.

As the name suggests, they allow you to save in cash, which can make them highly flexible if you need to access your money at short notice. This can be useful if you encounter any financial emergencies.

Due to the tax rules for ISAs, you don’t have to pay Income Tax on any interest that your wealth generates while you hold it in your account. This can help your money to grow more effectively.

Stocks and Shares ISA

A Stocks and Shares ISA is another popular type of account, which allows you to invest your money in the stock market and other assets instead of just holding it in cash. This can potentially lead to much greater returns than a Cash ISA in the medium and long term.

As with Cash ISAs, you don’t have to pay Income or Capital Gains Tax on any returns that you generate through it, making it an efficient way to grow your wealth.

Of course, it’s important to remember that whenever you invest your wealth in a Stocks and Shares ISA, you also expose it to some element of risk. Remember that the value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Lifetime ISA

Lifetime ISAs are another popular savings vehicle, as they have the dual purpose of helping people aged 18 to 40 to either save up to buy a home, or to start building up their retirement savings.

The main benefit of this type of account is not only is it one of the most tax-efficient ways to grow your wealth, but that the government will also top up your contribution by an extra 25%.

Because of this useful benefit, you have a lower annual allowance (more on this later) of only £4,000, unlike other types of ISA. This means that if you contribute the full amount into your Lifetime ISA in a tax year, you’ll receive an extra £1,000 in government bonus.

However, it’s important to bear in mind that you can only access the money in your Lifetime ISA when you come to buy your first home, or at the age of 60. If you try to access it earlier than this, you may incur a significant charge.

How much can I save into an ISA?

Since ISAs can allow you to earn tax-free returns on your money, there is an annual limit for how much you can save into your accounts. This is known as your “ISA allowance”.

Each tax year, which is 6 April to 5 April, you can only save or invest up to the ISA allowance. In the 2021/22 and 2022/23 tax years, this allowance is £20,000.

Please bear in mind that this limit is across all your ISAs and not for each individual savings account. ISA allowances are also not carried forward at the end of the tax year, so if you don’t use it, you lose it.

As previously mentioned, it’s also important to remember that Lifetime ISAs have a much lower annual allowance of only £4,000. This is because of the valuable benefits that they offer. This £4,000 does count towards your overall ISA allowance.

What is a SIPP?

When saving for retirement, SIPPs can be a great way to build your wealth in the long term. One of the biggest advantages of saving in this way is that you can benefit from tax relief from the government on your contributions.

However, since this is a pension, you can only access it once you reach a certain age. This is currently 55, but will rise to 57 from 6 April 2028. While this certainly helps to remove the temptation of dipping into your savings pot, it can be a problem if you need to access your funds at short notice.

When you are able to access it, you have the option to take 25% of your pension pot as a tax-free lump sum. However, any money that you take on top of this will be taxed at your marginal rate of Income Tax.

What are the benefits of saving into a SIPP?

There are four main benefits of contributing to a SIPP.

1. You can save a large amount into it each year

One of the main advantages to using a SIPP is that your pension Annual Allowance for how much you can pay into it is much greater than with an ISA. This can make it easier to grow your pension wealth.

In the 2021/22 tax year, you can contribute and receive tax relief on up to £40,000 or 100% of your earnings in a SIPP, whichever amount is lower.

2. You can open them at any age

While a Lifetime ISA can be a very useful way to build up retirement wealth, you can only contribute into them for a limited amount of time. After the age of 50, you won’t be able to pay into it or earn the 25% bonus, although it will continue to stay open and earn interest or investment returns.

This can pose a problem if you were hoping to boost your pension contributions in the run-up to retirement.

A SIPP, however, can be opened at any age and you can pay into it up until the age of 75. This can be useful if you want to start saving for retirement closer to the time.

3. You can benefit from tax relief

Tax relief is one of the most important benefits of saving into a SIPP and it can greatly boost the value of your pension fund. The amount that you’ll receive depends on how much tax you pay:

  • If you’re a basic-rate taxpayer, you’ll receive 20% relief on your contributions
  • If you’re a higher-rate taxpayer, you’ll receive 40% relief on your contributions
  • If you’re an additional-rate taxpayer, you’ll receive 45% relief on your contributions.

For example, if you pay the basic rate of tax and make a £100 contribution to your pension, it would only “cost” you £80 as the government would add an extra £20. This is because they would be paying tax relief of 20%.

Higher- or additional-rate taxpayers must claim the higher rates of tax relief through their tax return.

4. You can choose your own investments

Unlike the majority of personal pensions or workplace schemes, you can choose your own investments in a SIPP. This can give you more control over how your funds are invested.

How much can you save into a SIPP?

As mentioned previously, you can contribute and receive tax relief on the lower amount of up to £40,000 or 100% of your income into your SIPP in the 2021/22 tax year.

It’s also important to bear in mind that there is a lifetime limit to how much you can save into your pensions without incurring a tax charge. This is called your “Lifetime Allowance” and, in the 2021/22 tax year, stands at £1,073,100.

Theoretically, nothing stops you from saving over this amount. However, if your pension exceeds the Lifetime Allowance, then any value of your pension that you withdraw over this limit will be subject to a tax charge. This could be up to 55% if you withdraw a lump sum from a pension that exceeds the Lifetime Allowance.

If you want to ensure that you don’t run into any potential tax issues when you come to retire, you may benefit from speaking to a suitably qualified financial adviser. This can help you to understand the relevant pension and tax rules so you can make an informed decision that suits your personal circumstances.

Frequently asked questions

Is a SIPP better than an ISA?

Both ISAs and SIPPs can be good ways to build your wealth, each coming with different benefits. ISAs can be useful if you want to reach medium-term goals, such as buying a house, while SIPPs are exclusively for saving for retirement.

Both savings vehicles have advantages and disadvantages, so it’s important to think carefully about what you’re saving for.

Can you have both ISA and SIPP?

Yes, you can have both ISAs and SIPPs at the same time, so there’s no need to worry about choosing between them. ISAs can be useful for reaching your medium-term goals, while SIPPs are only suitable for saving for retirement.

Is it worth having a SIPP?

In some circumstances, a SIPP can be a good alternative to having a workplace pension scheme. However, it’s important to bear in mind that you have to be comfortable making your own investment decisions when you have a SIPP.

If you don’t feel able to do so, you may benefit from seeking professional investment advice so you can grow your pension pots in the most effective way and avoid having to pay tax unnecessarily.

How does your Income Tax band affect your tax relief?

Receiving tax relief on your contributions is one of the biggest benefits of saving with a SIPP. Typically, the higher your marginal rate of Income Tax, the more tax relief you can receive from the government when you contribute to your pension pot.

Please note

This article is for informational purposes only and does not constitute financial advice. All contents are based on my understanding of HMRC legislation, which is subject to change.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.

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