Pension versus EasyISA

Along with our successful ISA wrapped product, Chelsea are now pleased to announce the Cofunds SIPP, via Chelsea FundStore.

The changes announced in the March budget were good news for investors, and the savers revolution looks set to continue. George Osborne's latest move was to scrap the 55% death duty currently levied on pensions. So, where has this left investors? Should we be putting our money in an ISA or a SIPP? The wrong choice might cost you thousands of pounds.

The new ISA or NISA ,which was introduced in July this year, is very similar to its predecessor, but gives more flexibility to the investor. It still provides shelter from both capital gains and interest paid out, but with the welcome increase to £15,000 per year. The other major difference allows investors to switch their investments from stocks and shares ISAs to cash ISAs, as little, or as often, as they like. To top up your ISA simply:

     

So, what are the differences between these two products?

SIPP - Advantages

• You get your tax back just for investing. The basic rate of tax is automatically added to any personal contributions. For example, if you contribute £80 the government adds another £20 to make a total of £100 (£80/0.8). Higher rate and additional rate tax payers can also claim back even more tax from HMRC on their tax return.
• You get protection from capital gains tax.
• You can take 25% of your SIPP as a tax-free lump sum at retirement.
• Currently anyone who inherits a SIPP from someone over the age of 75 or from someone who is currently drawing an income, has to pay 55% tax. The exceptions being spouses and children under 23. The new law will mean anyone who inherits a SIPP from someone who is under the age of 75 does not incur a tax liability. If the SIPP is inherited from someone over the age of 75 the SIPP can now be drawn down at the inheritor's marginal rate of tax, either 0%, 20%, 40% or 45%.*
• You can now leave your SIPP to anyone, not just your spouse or a dependant, making them much more flexible.
• Like an ISA there is no tax on interest earned on bonds or bond funds and a 10% tax cap on income from shares or equity funds.
• You can contribute to a pension, outside a specific tax year, depending on certain terms and conditions. These stipulate that you can carry forward the previous three years allowance, as long as you have earned the contribution amount in that current year.

Disadvantages

• You can’t touch it until you retire. You must be a minimum of 55 years old (this rises to 57 in 2028) before you can withdraw.
• When you take money out from your pension pot you are charged at your marginal rate of tax (except for the 25% tax-free lump sum).
• You are currently limited to contributing a maximum of £40,000 a year.
• Your total pension pot currently cannot exceed £1,250,000, the lifetime allowance, before punitive taxation of 55% on anything you drawdown above this sum kicks in (the tax is only 25% for an annuity, but then you will have to pay your marginal tax as well).
• SIPPs are more complicated.
• There may be charges for going into drawdown.
• Despite the recent changes, pensions are still inflexible compared with ISAs.

ISA - Advantages

• Any investments inside the ISA are free from capital gains tax.
• There is no tax on interest earned on bonds or bond funds and a 10% tax cap on income from shares or equity funds.
• No further tax to pay on income taken from an ISA.
• The money can be accessed any time; if you need it in an emergency or if you are saving towards a goal, for example buying a house.
• You can switch back and forth between a stocks and shares and a cash ISA, depending upon your investment needs.
• Simple, flexible and easy to understand.

Disadvantages

• You are currently limited to investing a maximum of £15,000 a year. If you do not use this in the current year, you cannot use it the next year.
• Upon your death, the ISA wrapper dissolves and your ISA investments just become part of your estate and is subject to inheritance tax.
• No tax relief on contributions.

With all that information, you may now be able to decide whether a SIPP, or an ISA is better for you, but to help you that little bit more, why not consider the following:

• A 25 year old invests £2,000 into both an ISA and a SIPP.
• The SIPP sum is increased by the basic rate of tax of 20% (£2000/0.8) to a total of £2,500.
• Both investments return 7% a year after charges.**

At the age of 65 the SIPP is worth £37,436 and the ISA is worth £29,949.

At first glance the SIPP may appear better, you will always have a larger final lump sum by investing in a SIPP versus an ISA, because of the tax relief (assuming you make the same investment in both products). However, remember that you must pay tax, at your marginal rate, on any income you take out of a SIPP, whereas income from the ISA, is not subject to further tax.  The major benefit of the SIPP is that you can take a 25% tax-free lump sum on retirement.

The new flexible drawdown option announced in the budget (due to come into effect next April) gives investors much more freedom and control over their SIPP when they come to try and take money out. The 25% tax-free lump sum means that in most cases you will be better off with the SIPP, even after accounting for paying the tax to take income out. One notable exception is when you move into a higher tax band when you retire. In this case, you might pay more income out when you retire versus what you received from the government when you paid into your SIPP in the first place.   

One disadvantage of the SIPP, particularly when you're young, is that it locks your money away until retirement. Nevertheless, I hope the example above shows how important it is to start investing as a priority, no matter which vehicle you use. For those still in doubt I would encourage you to read our blog on compound interest.

Let us now consider, ISAs versus SIPPs for older investors. Unlike younger investors, older investors at or nearing retirement, will be able to access their money sooner. In most cases, the combination of the tax relief when you invest and the 25% tax-free sum when you drawdown, might make a SIPP a better choice versus an ISA. However, it will depend on your own personal circumstances, and investors must be careful how they drawdown their money to avoid paying too much tax in one go. You should also be aware that SIPPs will typically come with extra charges when you enter drawdown so this should be factored into any decision.

One thing to bear in mind is, as we have recently seen, the government can change the rules at any time. We might have a new government next year and a new set of laws. Investors should prepare themselves for any scenario as best they can. With this in mind, we continue to like investing in both products, but you must ultimately decide what is best for you. If you're in any doubt seek expert advice.

In conclusion, ISAs have been incredibly popular and remain a great tax-efficient and flexible product for savers. However, there is no doubt that Osborne's revolutionary changes have made investing in a SIPP look much more attractive than before. Long-term investors may want to consider investing more into their SIPP.

For more information on our new SIPP, click here.

*http://www.bbc.co.uk/news/business-29408928
**Chelsea internal calculator