ISAs and SIPPs

Please note that tax rules and reliefs are subject to change by the government.

Investment ISAs

An Investment ISA allows you to invest in a tax-efficient way, as any gains made on investments within an Investment ISA are free from Capital Gains Tax. Furthermore, you do not have to declare any income from them on your UK tax return, making them particularly beneficial for higher-rate taxpayers.

How much can I invest in an Investment ISA?

In the current tax year (which runs from 6 April 2020 to 5 April 2021), the maximum you can deposit in an investment ISA is £20,000.  This assumes that you have made no other contributions to other ISAs in the current tax year.

Where can I get an Investment ISA?

You can get an Investment ISA by going to an ISA manager. These include banks, building societies, insurance companies, unit and investment trust companies, financial advisers, fund supermarkets and stockbrokers.

Some ISA managers will offer ISAs that can include only their company’s products, while others may offer a choice of their own and other companies’ products. However, some may offer “self-select’ ISAs.

What is a Self-Select ISA?

A self-select ISA is one in which, as the name suggests, you choose which stocks and shares you want to hold.

If you wish to choose your investments from the widest range of stocks and shares within an ISA and you are happy to make your own investment decisions, then a self-select ISA is the best option.

Investing within a Self-Select ISA

Advantages

Investment choice – you have a far greater choice of securities to invest in

Low cost – you can grow your ISA over time, adding to your investments each tax-year (subject to the annual limits).  This will generally mean that any annual administration costs for running your ISA as a percentage of your ISA’s value will fall.

Quicker dealing – trade ‘real-time’ online

Easy administration – by having several years’ of ISA allowance with one provider

Flexibility – you can access money in an ISA at any time, although once you take money outside of the ISA wrapper, you cannot put it back in if you’ve utilised the current year’s allowance.

Disadvantages

No ‘up-front’ tax relief – the government grosses up pension contributions according to your tax band ie a £1,000 contribution will be grossed-up to £1,250 for basic-rate taxpayers.

Restricted annual allowance

The disadvantages can be alleviated by using of a Self-Invested Personal Pension, or SIPP.

Investing within a Self-Invested Personal Pension (SIPP)

Advantages

Investment choice – you have a far greater choice of securities to invest in

Low cost – you can grow your SIPP over time, adding to your investments each tax-year (subject to the annual limits).  This will generally mean that any annual administration costs for running your SIPP as a percentage of your SIPP’s value will fall.

Quicker dealing – trade ‘real-time’ online

Easy administration – by having several years’ of SIPP allowance with one provider

‘Up-front’ tax relief

Disadvantages

Poor flexibility – you can only access money in a SIPP when you reach age 55

Restricted annual allowance

Which is better, investing in a self-select ISA or investing in a SIPP?

Both!  SIPPs are more tax-efficient, but ISAs are more flexible.  The extent to which you choose to invest in one over the other depends on how you think your tax status will change over time and how much flexibility you need.  However, a good retirement strategy will include both types of tax wrapper.

What are the tax differences?

The personal pension is more tax-efficient because you receive tax relief on your contributions. The government grosses up pension contributions according to your tax band. This is done automatically for basic-rate taxpayers, but higher-rate taxpayers need to claim back their extra relief separately.

Note too, non-taxpayers also receive 20 per cent basic-rate relief (up to £3,600 gross). Grossed up, basic rate and non-taxpayers making a net contribution of £1,000 receive £1,250.  If you pay higher-rate tax, the government will gross up a £1,000 contribution to £1,667.  If you pay 45% tax, a £1,000 contribution is grossed-up to £1,818.

However, tax is payable when an income is taken from your pension pot. In comparison, an ISA gives you no tax relief on the way in, but the proceeds are free of tax.

A personal pension is also more tax-efficient than an ISA for two additional reasons:

• You can take 25 per cent of your pension pot as a tax-free lump sum

• You are likely to pay less tax in retirement than while you are working. This is particularly true for higher-rate taxpayers who receive 40 per cent tax relief on their contributions but may only pay 20 per cent tax on their pension income in retirement.

You currently need an income over £50,000 to be a higher-rate taxpayer, based on the 2020/2021 tax year. To generate a retirement income of that level requires substantial pension savings as annuity rates are so low. That means relatively few pensioners are 40 per cent taxpayers in retirement. Even basic-rate taxpayers will pay less than 20 per cent tax on a large chunk of their income in retirement because the first £12,500 of your income is tax-free.

Why are ISAs more flexible?

Money in an ISA can be withdrawn at any time, whereas there are restrictions on how money in a pension fund can be withdrawn.  For example, you can only withdraw money from a pension from age 55, and only 25% can be taken as a tax-free lump sum.

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