SIPP or ISA

BT

I was going to invest all spare cash into an ISA but then found info on SIPP and started thinking why open an ISA when a putting money into a SIPP give you a 20% boast in the form of tax relief.

So if my understanding of this is correct, I could say put 8K into a SIPP and the Government will add 2K making my pot 10K. Then, when I reach 55 (few years’ time), I will be able to take back 2.5K tax free (assuming no growth). Not sure of my options with the remaining 7.5K.

Also:

If there is growth in my 10K pot, is the growth tax free?

Once 25% of the SIPP pot it is taken out, Is there a tax free way to get the remaining 75%?

Is my understanding correct? Have I missed something?

BTW, I’m am in a company pension plan, opted out of serps (don’t know why), lower rate tax payer and really need to start understanding Pensions & Tax so that I can start planning my financial future.

redmalc

Absolutely correct,my wife is a non tax payer and every year I put in £2880 in a sip and the nice government give us £700 long may it last

bowlhead99

BT wrote: »

If there is growth in my 10K pot, is the growth tax free?

I would say, "Yes and no". The conventional answer is yes, because just like with an ISA, if it starts at 10k and moves to 20k in a year or a few years through capital gain, interest, dividend, the taxman is not concerned. No tax is taken off the pot as it merrily grows along. So when doing the maths on what 5% growth or 50% annual growth means for the total size of the pot, you don't have to worry about tax reducing that.

However, at the end of the day it is your salary that you haven't been taxed on yet (because you took the tax relief in turning £8k of net contributions into £10k of gross pension pot at the start), and when you take the money out of the pension wrapper you will need to pay tax on it at your normal marginal rate in the year you take it. Only 25% of it definitely escapes tax.

So if there has been no growth and you have 10k in the pot you will get 2.5k tax free and you may need to pay tax on the 7.5. If the pot grew to 20k you will get 5k tax free but now you will be paying tax at your marginal rate in the year you take it, on 15k. If the pot grew to 100k you will get 25k tax free but may need to pay tax on 75k. So, you saved 2k tax at the beginning but instead of paying the 2k tax on 10k you are paying tax on 75k. If you had paid the tax at the start and put your net 8k salary in an ISA and it went up 10x in value, the total pot would only be 80k instead of 100k but there would be no tax to pay on it.

So as an example:
ISA: Get 10k salary. Pay 2k tax at your 20% rate. Left with 8k. Invest for a long time so it grows tenfold, turn it into 80k with no further tax to pay.

Pension: Get 10k salary. Put it in a pension so income tax was claimed back and you still have the 10k not 8k. Invest for a long time so it grows tenfold to 100k. Take the 100k and pay your 20% tax to leave you with 80k (ignoring the 'tax free lump sum'). Same overall basic result from your investments.

EXCEPT, two important things.
1) You get 25% of the pot as a tax free lump sum so actually only pay tax on 75k, assuming you are still on a 20% basic tax rate you're left with 60k from the 75k, PLUS the 25k lump sum in your hand with no tax, making 85k total. So your result from using pension instead of ISA is about 6% better, for a lot of people (85k vs 80k).

2) Your marginal rate when you are in your late 50s or your 60s or 70s or whenever, when you take out the 75k, may not be standard 20% basic rate.

If for example the annual personal allowance for income tax is £10k a year and you get £5k a year of state pension and £2k of employer pension a year, you can take £3k out of your remaining £75k pension pot without it costing you a penny in tax, because your marginal rate is 0% at that level.

Alternatively if your state pension is £6k and your employer pension is £50k then you are firmly in the 40% tax bracket and if you took £3k out of your personal pension you would be paying 40% tax = £1.2k, not 0% tax = £0k.

If you took out the whole £75k at once and you didn't have any state pension or private pension or employment income that year, then you would get a slice of it at 0% then a slice of it at 20% then a slice of it at 40% to get some overall blended rate.

Once 25% of the SIPP pot it is taken out, Is there a tax free way to get the remaining 75%?

As above you can take some of it in a year where you don't have any other income and make use of your 0% band. So for example if you stopped working at age 60 you would perhaps not be receiving any state pension and not receiving any employer pension yet, and not getting any employment income, so you could get about £10k of your personal pension without paying any tax.

Obviously if you need £15k or £20k to live on during that year, you are not going to be able to just take 10k tax free and wait for the next tax year for your next slice of income because you will run out of money. But the availability of your '0%' band in the years after stopping your salary and before starting your pensions, could be quite handy.

System

I have been debating the same question myself. My main concern is that you dont know what future governments will do with pension rules (or indeed ISA rules). As it stands at the minute a SIPP looks marginally favourable, however this may not be the case in 10,20 or 30 years.

Generally a good course of action is to use both formats (if you become a higher rate tax payer the sipp is definitely advantageous at present). However depends on individual circumstances, e.g. what employer pension you already have, if you will need to access funds before retirement etc..

SeniorSam

Depending on your financial situation, remember that money in a Sipp will be protected from the value of your estate, as it is within a Trust.

All ISA's are part of your estate and if inheritance tax may be an issue, a Sipp is far better option.

atush

I agree that a pension (not necessarily a Sipp) would be a good choice for you.

But as with many you ask x 0r y, when the true answer is BOTH x and y. AS both pensions and Isas have their place.

Both allow tax free growth, both allow some tax free access (for pensions it is the 25% TFLS plus any pension you can draw using your PA).

Dont forget the PA is set to rise to 11K (but what balls will do with that is anyone's guess) and that if you retire early before SP you can get more out of your pot tax free as a result.

kidmugsy

Pensions don't intrinsically avoid tax, they defer it. That's good if the money goes in side-stepping 20% tax and emerges with 0%; or goes in side-stepping 40% and emerges at 20% tax. But what if it goes in side-stepping 20% tax and, when it emerges, it has to pay the basic rate of tax, which has risen to 25%?

To tie up money for decades, where it will be a hostage to fortune, needs quite an incentive. For me, the prospect of 20%/20% isn't enough: 20%/0% is, 40%/20% is, and 40%/0% is wonderful.

Personally, I'm prepared to tie up money for a few years, side-stepping a 20% tax bill and expecting my widow to pay 0% when she "inherits" it.

BT

Thank you all for your replies – especially bowlhead99 for the examples which were very helpful in understanding this.

So it would appear SIPP does have a marginal benefit which works out much better than current saving rates for ISA or otherwise.

Question: If my pot was 10K and I take 25% out as tax free – I assume this will have no impact on my basic tax rate as I’ll still be working.

If the remaining 7.5K is also taken, could this + my salary impact my tax rate and bump it up to 40% rate?

SeniorSam

The 25% tax free lump sum does not impact on your income tax level. However, any drawings after that will add to your present income tax level and if that were to take you above the 40% band, then yes, you would pay the 40% on any amount above the higher tax rate band.

atush

current saving rates for ISA or otherwise.

when we say ISAs for retirement savings, we aren't talking cash- we are talking a S&S isa