Russ Mould, AJ Bell Investment Director, explains the different advantages of saving for retirement using an ISA or SIPP.
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00:04 - Saving for the future can seem very complicated. Where do you start? Where can you get information that uses plain English? What do all these abbreviations mean?
00:16 - Hello, I’m Russ Mould, AJ Bell’s Investment Director, and I’d like to talk to you about the options you have when it comes to saving for your retirement and which is best: an Individual Savings Account (or ISA) or a Self-Invested Personal Pension (a SIPP)?
00:16 - Both are what are known as wrappers, places you can put your investments to shelter them from tax and help your savings grow. Each has its own advantages and which one you prefer will come down to your own personal circumstances.
00:43 - Now, first up, an ISA operates under a TEE regime.
00:43 - This means you put taxed income into the wrapper but any gains you make and any ultimate withdrawals are (generally) tax-free – hence TEE, or Taxed Exempt Exempt. Those tax breaks are a big plus in favour of ISAs, so here’s one point to them.
01:05 - With a SIPP, you get tax relief on the way in: for example, if you are a twenty per cent taxpayer, you contribute eight thousand pounds to your SIPP and the Government tops you up with another two thousand, making ten grand in total. During the SIPP’s lifetime, any gains or dividends are also (generally) free of tax and the first twenty five per cent of any ultimate withdrawal is tax-free too; the remainder is then taxed at your marginal rate, twenty, forty or forty five per cent.
01:33 - This means SIPPs operate under an EET regime – Exempt, Exempt, Taxed.
01:40 - The tax reliefs are a huge boost – the Government wants you to save and is offering you cash with which to do so, so that has to be a point in favour of using a SIPP for your retirement.
01:50 - SIPPs have other tax advantages, too, especially if you plan carefully.
01:56 - You can use your personal allowance and annual allowance, so the first chunk of any benefits withdrawn in a given year can also be tax-free. In twenty fifteen it is the first ten thousand six hundred pounds and in twenty sixteen/seventeen it is the first £10,800.
02:12 - Next, you can carefully phase any withdrawals from your SIPP so you stay in the twenty per cent tax band, maximising the value of any tax reliefs on the way in, especially if you are now a forty or forty-five per cent rate payer, because of your other income. Were any withdrawals to take you in to the upper tax brackets, then your pension income can also be subject to forty or forty-five per cent tax.
02:35 - Plus you can initially withdraw twenty five per cent of your SIPP as a tax-free Pension Commencement Lump Sum (or PCLS).
02:44 - The table behind me summarises the tax reliefs, marginal tax rates that apply on withdrawals and the potential tax benefits of using an ISA and a SIPP.
02:55 - Now, let’s try and turn this into a practical example with two people, Tom and Alice.
03:00 - Tom is a twenty per cent tax payer. He invests eight grand a year for twenty years in an ISA and this portfolio gives him a four per cent annual return. He ends up with this figure here (£247,754).
03:10 - Alice she’s also a twenty per cent tax payer. She also invests eight grand a year for twenty years but does it in a SIPP and also gets four per cent annual return. She ends up with this sum (£309,692).
03:22 - The big difference comes the upfront tax reliefs on her SIPP contributions which give her more money to invest each year.
03:30 - Tom then retires and withdraws four per cent a year from his ISA. He gets this sum each time, with no further tax hit (£9,910).
03:39 - Alice then retires and also withdraws four per cent a year from her SIPP. On a like for like basis she gets this figure (£12,276).
03:46 - But she can then use the personal allowance so she only pays twenty per cent tax on the other sixteen hundred seventy five so she can take out this amount each year (£12,030) – twenty one per cent more than Tom!
04:00 - Better still, if Alice uses the PCLS she can take all of the twelve-grand-plus tax-free assuming she has no other income.
04:10 - She can take three thousand and ninety seven pounds as her twenty five per cent tax-free lump sum and the remaining nine thousand two hundred and ninety one pounds come within the personal allowance– so there’s no tax to pay at all, in this particular circumstance.
04:26 - Now, there’s nothing like cold hard cash to focus the mind and that exercise does show the power of the tax reliefs enjoyed by SIPPs.
04:34 - I’m sorry to say the next issue to consider is what happens when we die – it’s not nice but one point of saving is to look after our loved ones.
04:43 - With an ISA, your spouse or civil partner gains extra allowance that they can then pay into their ISA to effectively keep the tax benefits of your portfolio.
04:52 - But SIPPs have some advantages here too.
04:56 - On death, the SIPP can be passed on tax-free if the deceased is aged under seventy five.
05:03 - SIPP nomination forms, readily available on our website, mean you can make a nomination that tells us as your scheme administrator who you would like to receive the benefits. If the deceased is over seventy five then the benefits are subject to income tax, but by carefully electing who you want funds to be passed to you can still plan in a tax efficient manner - picking your children or grandchildren, for example, could save on tax, assuming your partner doesn’t need the money.
05:29 - Moving swiftly on from morbid thoughts, we can close out with a few other options for retirement savers to consider.
05:34 - With an ISA you can access your cash whenever you wish, so they are very good for early retirements – with a SIPP you must be fifty five before you access your pot.
05:45 - You may have to wait to access your SIPP but you can do so in several ways – by taking the whole fund in one go, withdrawing small lumps and / or taking a regular income – these different mechanisms allow you to choose how much money you would like to take and when, to best suit your needs and circumstances. This means a SIPP can be a very flexible saving tool, some of this does also apply to ISAs, both wrappers score a point here.
06:13 - And that’s about it – SIPPs have come out on top for retirement saving because of the tax reliefs (which more than offset some of the extra costs associated with a SIPP, relative to an ISA) BUT they are three final points I’d like to make:
- One, both wrappers help shelter your savings from tax so they can grow quicker and ISAs and SIPPs can be used together
- Two, ISAs can have a role to play especially if you want to retire early or even need the cash before you retire
- Three, SIPPs do seem more subject to rule changes so you need to keep up to date and we will certainly do our best you help you here. Thank you for watching and I look forward to seeing you next time.