SIPP Versus Stocks & Shares ISA
There are two wrappers for saving money without actually definitely for sure becoming less well off. But first I’ll illustrate the best way to for sure actually definitely become less well off.
Cash
Since the apocalypse of 2007, and now the zombie apocalypse of 2020, cash savings rates have plummeted. For an account without a stupidly low maximum balance or monthly deposit limit, the rates are around 1% with easy access up to ~1.6% for fixed terms without easy access. There are a few permutations relating to ISAs and tax rates but nothing is really going above these rates.
Inflation
So one might think “OK i’m getting 1% it’s better than nothing right. Oh look a robin!” But they’d be wrong. Maybe there is a robin, but in actuality your money is decreasing in value still. Over the last 20 years inflation has averaged around 2%. Check out the fun picture below.
So each year you feel like you gain 1% but you’re actually losing 1% overall (1% up, minus 2% down).
In essence this means that £100 pounds in your wallet today is worth £98 this time next year. That £98 is then worth £96.04 the year after that. Ten years from day 1 your £100 would be worth £81.70.
This is not to say your actual savings balance goes down, but the spending power of it has decreased by this much. A gluten example:
Taking the inflation figures for the last 20 years, a loaf of bread cost 51p (thanks ONS) in March 2000, the March 2020 price of that same loaf of mouldy bread is now £1.05.
So if we were doing all our saving in cash accounts then at best the spending power after a year in any of the current savings accounts will have gone down by ~1%. That may not sound like much, but take that over 10 or even twenty years and it’s pretty easy math to show the power of that growing balance will be near 10% and 20% lower respectively.
Why is this relevant? Along with saving for a holiday, or a new top hat, many of us want to try to de-risk the future, and save long term. Where long term can mean more than 20 years, inflation can do real damage to your savings and thus your future quality of life. Provided there isn’t a revolution centered around love and caring for our fellow humans. The last example here:
Let’s say you’ve done some planning and budgeting and are certain you can live on ~£1,000 a month when you retire in 20 years time. Miraculously you’ve saved £20,000 under the mattress and so you’ve got 20 years of worry-free retirement sorted. Fast forward 20 years of 2% inflation. Along with bread costing almost twice as much (see the above example), everything else has increased and so to be able to live to your plan (haircuts, tv, internet, food, transport, holidays etc.) you’ll now need ~£1,500 a month. Your worry-free 20 years is now a stress-filled 13 years. If you’d put that amount into a savings account at 1% you’d make it to around 16 years. Pretty depressing.
The Main Meal
Stocks & Shares ISAs and Self-Invested Personal Pensions.
The fourth word of this diatribe was ‘wrapper’. By this I mean to suggest that whatever we do next that isn’t cash, we’ll be buying something, and there are two main ways of buying these somethings that we are interested in. The obvious inference should be that what we buy will grow in value more than the terrible cash situation above.
I’ll post another violent outburst of my opinions on what exactly we should buy in a later article.
I’ve made this lovely table to sum up the attributes of each contender. Below this I will attempt to compare and contrast the most pertinent differences.
Contribution Limits
This is pretty simple, fixed figures for the maximum you can put in each wrapper in each financial year. It would take you roughly 15 years at the maximum annual contribution amount to reach the £1m SIPP cut-off, so for most of us (and this article) that isn’t too much of a concern. Basically anything over that ~£1m amount starts to attract tax.
Winner: For the average person, it’s a draw.
Contribution Tax Relief
Anything you add to a S&S ISA will generally be from money you have available after getting paid. And so tax has already been taken for that amount .
Example: You earned £1,000, HMRC takes 20%, you take home £800.
The SIPP wrapper builds in recognition that you’re being a good pension saver and automatically results in you being refunded 20% of whatever you add to the SIPP. You can see this makes the SIPP behave pretty much like a company private pension if you’re a basic rate tax payer.
Example: You put that entire £800 into your SIPP, £200 extra gets added shortly after.
Additionally, if you are a higher rate tax payer, which is 40% on anything over £50,001 up to £150,000 as of 2020, you can claim the extra 20% via a Self Assessment tax return each year.
Winner: Pound for pound, the SIPP wins by significantly increasing your something buying power.
Capital Gains Tax
Neither have any business here (incidentally a non-ISA share dealing account would get hit here).
Winner: Both!
Distribution Tax
You can take a 25% lump sum from your SIPP tax-free. This can be implemented a few ways, such as literally taking that lump sum, or taking the first 25% of each draw-down tax-free. The remaining 75% of the SIPP will be taxed as income just as if you were earning it from a job.
Note that this means the first £12,500 you take is tax free, and whilst this amount is expected to increase over the years, the spending power implied by this figure should remain the same. Note also that there are no NI contributions.
The S&S ISA has no tax involvement whatsoever.
Winner: Clearly it’s better to pay no tax, S&S ISA wins.
Lock-in Period
This is the probably-predictable catch with the SIPP, just like a private pension, 55 is the earliest age you can take anything out of it. There’s also proposed legislation to raise this to 57 by 2028. It’s not through yet, but would make sense to align to the rising state pension age.
The S&S ISA can be accessed whenever you like. This can be good:
You decide to run away to Antigua with the vet who saved your cat from cat rabies…
… or bad:
You’ve got no willpower and keep buying luxury rabid cats and run out of money.
Winner: If you want to retire before 55/57 the ISA wins, if you struggle with self-discipline then the SIPP wins. It’s a draw.
Note: I’m assuming you have a contingency fund in cash/easy access to cover for ~3–6 months unemployment and usual costs of life such as car breakdowns etc. That should almost always be able to negate any need to access your ISA, and be the first thing you sort before trying any of this gibberish.
The final score is:
SIPP: 3
S&S ISA: 3
Bit of a disappointment! But in reality they are both great options and as I’ve shown above, each has slightly different pros and cons.
Which One is for Me?
The below table shows where I’d put my money in a few scenarios. Below this is my attempt to justify it.
I should add, before going into this next bit: Do the calculations, work out whether you believe you can retire early (if you even have any desire to) before trying to decide on the best approach here. There are plenty of compound interest calculators to get you started. I’m pretty sure if I haven’t already, i’ll have written something on that soon as well.
Retire Date Early
If you want to retire before 55 or 57, then the S&S ISA is the only wrapper that will provide for this flexibility.
As a higher rate tax payer you might wish to choose both so as to capitalise on the significant tax relief available. The implication is the contributions to the S&S ISA will maintain your post-retirement lifestyle up until at least the time you can access the SIPP. There are many ways to balance this so as to reduce the tax on draw-downs for the SIPP too, if you can keep drawing from both at the same time.
As a lower rate tax payer I think it’s more difficult to make the argument for investing in both wrappers. Or rather, the contributions to make both viable will be more demanding. if you’re a lower rate tax payer and cash rich still, then a blended approach is probably also worth considering.
Retire Date On Time
I believe SIPPs win in both tax scenarios here. My reason for this belief is that as a higher rate tax payer the significant tax relief of the SIPP has no down-sides unless you want an extended very extravagant retirement.
I think the same applies to the basic rate scenario.
Here too there is probably space to do both if you know you want more flexibility, for example to re-pay or finish off a mortgage earlier than 55, or you have reason to believe you’ll want irregular lump sums for whatever strange life you intend to live. My thoughts are mostly confined to “I want to retire as comfortably as possible.”
In summary, there’s no one right answer, though there are probably a few really bad wrong ones. Start saving early, read some books, never stop learning!
Coming up next, What the Heck do Invest In? Stay internetuned.