Friday 18th March
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When you’re saving toward your future, it’s critical that you make good decisions with your money. That means making the most of the various kinds of tax relief you qualify for. There are two systems in particular that are designed to encourage people to save, Self-Invested Personal Pensions (SIPPs) and Individual Savings Accounts (ISAs). Both offer real and valuable tax relief on the cash you’re socking away, but each comes with its own set of advantages and drawbacks. The specific tax wrapper (the “container” protecting your savings from tax) you pick will depend on what you’re trying to accomplish and how far you want to commit to it – and you may actually find yourself mixing and matching between different options for the best of both worlds.
The main thing that SIPPs and ISAs have in common is that you don’t get hit with tax when the savings you put into them grow in value. That means any interest payments, dividend income or capital gains you earn from them are all tax-free. In fact, you don’t even have to report those kinds of gain or income to the taxman.
Now let’s look at the ways they differ.
The government will top up your cash
With a SIPP, the tax main relief you get comes when you actually pay money into it. It sounds strange, but the government actually “tops up” the cash you pay in by the amount of tax you paid on that cash when you earned it.
So, assuming you normally pay tax on your income at 20%, if you paid £80 into your SIPP, HMRC would add another £20 on top – a total of £100 overall. That £20 basically refunds the 20% tax you were charged on £100 of your earnings through the PAYE system or your Self Assessment tax return. Of course, not everyone pays tax at the basic rate. If you’re charged a higher tax rate on some of your income, you can claim the extra 20% or 25% back through a tax return.
You can pay any percentage of your yearly income you want into your SIPP, but there’s a hard limit on the actual tax relief you can get. If you pay more than £40,000 into your SIPP in a year, you won’t get any top-ups from HMRC on anything over that amount. However, if your contributions don’t hit the £40,000 threshold, you can “carry forward” your unused tax relief for up to 3 years, basically stacking it up for future use. You might find this particularly helpful if your earnings tend to change from year to year – if you’re self-employed, for instance. If you can’t save up to the £40,000 threshold in one year, but earn enough to go over it the next, carrying your unused tax relief forward means you don’t miss out.
Unlike SIPPs, you don’t get any tax relief on the money you pay into an ISA. As a result, technically speaking, the after-tax cost of paying into a SIPP is much lower. ISAs also have an annual allowance of £20,000 for paying in, which can be split freely between any ISAs you have. The only exception is the Lifetime ISA, which you can only put £4,000 per year into at most (earning £1,000 in top-ups from the government).
Swings and Roundabouts
While the rules vary between specific ISAs, they can offer quite a bit of flexibility over how you get your hands on your savings. Because a SIPP is a pension, though, you’re a lot more restricted in that respect. For one thing, you can only access your money after the age of 55 (or 57 after 2028). Even then, there are some rules to keep in mind. Only 25% of your pension pot can be withdrawn tax-free, for instance. You’ll be paying your normal rate of tax on the rest when you access it. This is kind of a “swings and roundabouts” situation. Obviously, at first glance, it seems like a pretty huge drawback compared to an ISA. However, if you’re saving for your retirement, that extra restriction can make it a lot less tempting to pull your cash out early. In the long run, you could be glad you didn’t have such easy access to your savings as you would have had in an ISA.
Balanced against that, of course, is the fact that your SIPP savings might not be be available if you ever need them in a hurry. The flexibility of an ISA is great for taking care of unexpected emergencies. Also, if you’ve got shorter-term goals in mind (like saving for a house deposit), that easy access could be exactly what you need. Overall, then, SIPPs can be a really good way of investing in your long-term future. For non-retirement saving, an ISA will probably be the better choice.
Keep your goals clear
Of course, even though saving toward any target requires focus and determination, no one ever said you could only have one goal at a time. If you’re saving for your first home right now, but still have an eye on your eventual retirement, then a combination of SIPP and LISA savings options could help you hit both targets. The exact combination will obviously depend on your situation and aims. If you already own your own home, for instance, paying into a SIPP or workplace pension will help bulk up your retirement pot faster. If you need a new car, on the other hand, an ISA will get you on the road more efficiently, with easier access to your savings. Striking that balance is the key to making the most of your savings, so always start by working out exactly what you’re trying to achieve. Clear goals are always easier to reach than vague ideas.
Keep checking back here for more money tips and updates. We’re experts at saving you cash and we’re always here to help. That’s the reason why you’re better off with RIFT.
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