SIPP or ISA as additional savings vehicle

bd10

Hi all,

How would you weigh up a SIPP vs an ISA for primarily retirement savings?

SIPP:
As higher rate tax payer I'd be getting up to 40% tax refund on anything paid in. So, the overall yield would be at least 1.5% higher. The downside is the income tax payable on the 75% which would be not tax free.

ISA:
No incentives during the savings period but all tax free on the way out. Instantly accessible if another deposit for a property would be needed, that flexibility I really like.

Through work, a defined contribution scheme is in place already so a basic retirement income of around £25k-£30k/pa (excl. state pension) would be in place.

I cannot make up my mind how to allocate annual private savings (outside salary sacrifice pension scheme) of around £15k?

What criteria should I be looking at?

Any thoughts would be much appreciated.

dunstonh

How would you weigh up a SIPP vs an ISA for primarily retirement savings?

First you look at your objectives (current and future)
Then you filter out the tax wrappers that dont meet the objectives.
Then you compare the remaining tax wrappers to see which is best for your objectives based on your situation.

As higher rate tax payer I'd be getting up to 40% tax refund on anything paid in. So, the overall yield would be at least 1.5% higher. The downside is the income tax payable on the 75% which would be not tax free.

So you look the net position. 40% relief in. 15% tax out. 25% difference. Also outside of the estate and tax free pay out if death before 75.

ISA:
No incentives during the savings period but all tax free on the way out. Instantly accessible if another deposit for a property would be needed, that flexibility I really like.

But not as tax efficient as the pension.

AnotherJoe

I think you'd be certifiable if you gave up 25% free money from the government which is what you'd be doing if you didn't put it in a SIPP. 40% relief on way in, tax most likely 15% on the way out*
How do you make it "the overall yield would be at least 1.5% higher" Not sure what you mean by that?
The other thing to bear in mind is that high rate tax relief most likely isn't going to last indefinitely. Its an easy one for a left wing labour government to attack "unfair on the rich getting 2x the tax relief of the poor". So, take it whilst its going.
I

SA:
No incentives during the savings period but all tax free on the way out.

Often posted as a benefit but sounds less good when phrased as it actually is for a high rate taxpayer "Pay 25% more tax than in a SIPP"


* assuming you are standard rate when taking it, you'll be paying 20% tax, minus the 25% TFLS, so 15% effective tax rate.

jamiex

You should also consider the lifetime allowance for the pension and whether you're at risk of breaching that, as this could affect your decision.

Alexland

Why would you contribute directly into a SIPP if you can save a bit of NI by contributing more into the DC salary sacrifice pension scheme? My DC scheme allows me to occasionally transfer lump sums into a SIPP for more choice and lower costs.

I add enough into the pension to avoid higher rate tax (and child benefit clawback), then contribute £4k pa into a S&S Lifetime ISA (am under 40) then the rest into a S&S ISA.

Alex

bowlhead99

Simplistically, if your income in retirement is going to be £25-30k plus state pension, you probably have capacity to take a further £15k of taxable income in retirement before hitting higher rate taxpayer level.

If you can have £15k of taxable income (after 25% tax free) each year, that implies £20k being drawn out of the pension pot including both taxable and tax free parts. And to create £20k of sustainable retirement drawdown you would probably need a pot of £500k when you get to retirement. So, you probably have plenty of capacity to invest now (with 40% tax relief) and be able to draw down in retirement only paying 15% tax (20% basic rate but a quarter of it is tax free). That sounds a heck of a lot better than getting 0% tax relief now and paying 0% tax when you draw it out.

However, that's a simplification because:

a) if you have a huge defined contribution pension pot already in place, beware the Lifetime Allowance which charges you punitive rates of tax if you go over £1.055m of pension pot (though the limit will hopefully rise with inflation and there are some sensible planning things you could do to avoid hitting it) My casually saying you could build up a further private pension pot of half a million to generate £20k a year drawdown in retirement, doesn't really work if you are already at £1.054m and the limit doesn't rise with inflation etc.

b) The ability to get money out of your pension in retirement at 15% (20% less a quarter tax free) is contingent on not going over the higher rate threshold in any year. But if you wanted to pull £80k out of the pension for a sports car or home improvement one year, and £60k was taxable (25% tax free), you'd be paying 40% tax on some of that £60k, and so the marginal rate of tax on the £80k wouldn't be only 15%. It would still be a lot less than the 40% tax relief they gave you on the way in though, so is still better than using ISA with 0% tax relief.

You can invest in the same investment funds whether using ISA or pension, but if you don't use pension and don't get the tax relief, you're giving up potential free money in exchange for flexibility of access. The other downside of the ISA flexibility is that because an ISA is not "locked away from you", it's inside your 'estate' for inheritance tax purposes as well as being fair game for your creditors to go after (debt collection, bankruptcy proceedings etc) and for the government to count in any means tested benefits on which you're assessed. One or more of those things may be of relevance to you.

If you can't decide, and have £15k a year of spare money to save / invest, why not just
£5k cash (whether ISA or not, depending on rates available)
£5k S&S ISA
£5k pension

jonnygee2

No incentives during the savings period but all tax free on the way out. Instantly accessible if another deposit for a property would be needed, that flexibility I really like.

I think one thing you are missing is that the 40% tax rebate for the pension would be paid now. Then, it would accumulate interest.

£1000 invested now, growing at 5% for twenty years, would be c. £2600. £1400 ( £1000 + 40% tax rebate) would be £3700, so an additional £1,100 is being generated by the additional £400 input.

As Alexland points out, even better would be increasing your salary sacrifice level.

Reed_Richards

bowlhead99 wrote: »

... but if you don't use pension and don't get the tax relief, you're giving up potential free money in exchange for flexibility of access.

Complete flexibility and all tax free.

About 20 years ago I was in a similar situation but opted to use salary sacrifice and AVCs to keep myself out of the 40% tax bracket. Since then pensions have got a good deal more flexible, ISAs a little more and the amount you can contribute has gone up. What will happen in another 20 years?

The worst thing I can see happening to ISAs is that they will be abolished and the tax shelter removed. But if an ISA becomes just another investment/savings account then you still have complete flexibility and tax-free withdrawals

With pensions I wonder if people making ill-judged use of the access to their pension pot will cause a scandal and cost the government a lot of money resulting in a swing of the pendulum back in the other direction and more restrictions placed on what you can do with your pension pot.

bowlhead99

jonnygee2 wrote: »

I think one thing you are missing is that the 40% tax rebate for the pension would be paid now. Then, it would accumulate interest.

It doesn't really matter if the relief is pre-growth or post-growth; that's a red herring. You could invest £100 in ISA for a decade over which time it doubles in size to £200 and only then put it into the pension, getting the tax relief percentage then to turn it into something bigger than £200; or you could invest £100 in a pension now, getting the tax relief percentage now to turn it into something bigger than £100, and then let it double in size over the decade. You will still get to the same number if the tax relief percentage is the same.

The issue is that if you leave it for a while in an ISA before eventually deciding it should go into a pension for the higher rate relief, at that future point in time the amount of money you are trying to put into the pension might not fit into your annual allowance (e.g. £100 growing to £200 is no problem, but £20,000 growing to £40,000 doesn't fit into your annual pension allowance if you already have plenty of pension contribution going in from work that same year). Or the government might have done away with allowing high rate relief by that point.

£1000 invested now, growing at 5% for twenty years, would be c. £2600. £1400 ( £1000 + 40% tax rebate) would be £3700, so an additional £1,100 is being generated by the additional £400 input.

The 40% tax rebate makes it so that a £1000 gross investment only costs you £600, or a £1400 gross investment only costs you £840. The relief percentage equates to the gross, not the net. Just like when you eventually withdraw the money in retirement, you pay a rate of tax at published rates based on the gross amount of money being taken out of the pension, not on the net amount of money that arrives in your account.

As Alexland points out, even better would be increasing your salary sacrifice level.

Yes, you pay 2% national insurance if you take the money as cash whereas you don't if you sacrifice your salary and take the money as pension instead.

bd10

Million thanks everyone for the pointers!!

So, I ran some numbers, hope that makes sense: Let's assume a real yield of 5% taking platform fees into account. I also assume that I remain a higher rate tax payer and that the 20% refund via tax return remains in place.
The defined contribution pot would be worth 451,130 at retirement. Assuming that the lifetime allowance is still at 1,055,000, that would leave a gap of 603,869 which would need to be split between SIPP and share ISA. Taking the same real yield of 5%, that would translate into 11,251 annual savings over 26 years. But because I ma getting 20% relief and 20% refund, 11,251 / 1.44 = 7,813 per year.

Now, assuming 7% real yield net of fees which would be a lot more aggressive:
The defined contribution pot would be 631,772 and 423,227 would be the gap to the lifetime allowance. At 7%, this number would be reached with 8,816 per year savings over 21 years. Again assuming 20% tax relief and return, that would only be 6,122 per year for the SIPP. Any excess would end up in the share ISA.

Running the numbers made me realise that I actually need a split between SIPP and ISA, maybe 60/40 or 50/50. This of course depends on real yield assumptions and whether I want to retire on schedule or a few years earlier. But also squirreling money away into an ISA gives extra flexibility when it comes to another deposit for a property.

AnotherJoe

Reed_Richards wrote: »

Complete flexibility and all tax free.

It isnt tax free at all. Dont forget you paid tax on the way into the ISA.

Possibly up to 45% or so if a high rate taxpayer.

To call it a benefit that there's no tax on the way out ignores all the tax you paid on the way in. Its like thanking a mugger for leaving £50 in your wallet after he took it off you. The SIPP "mugger" only takes half as much.

Reed_Richards wrote: »

With pensions I wonder if people making ill-judged use of the access to their pension pot will cause a scandal and cost the government a lot of money resulting in a swing of the pendulum back in the other direction and more restrictions placed on what you can do with your pension pot.

The evidence so far is that there are far fewer people splurging their money than the fears that were raised by those inclined towards nanny-statism. I'm not going to search for it but there was a very recent study showing what had happened since the changes, which reported that pensioners were being (in general) too cautious with their spending.