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, so it's worth researching.
How do the Products Currently Stand?
The new ISA, or NISA, is very similar to its predecessor but is much more flexible. It still provides shelter from both capital gains and interest paid out, but you can now invest up to £15,000 annually instead of £11,880; a welcome increase. The other major difference is that the product is now more flexible - you can now switch back and forth between a stocks and shares ISA and a cash ISA.
In the March budget, chancellor Osborne announced major reforms for defined contribution pensions:
From April 2015, investors will no longer be forced into buying an annuity which, at today’s low interest rates, typically offered a poor level of income. Just this week, Osborne has gone further, and made pensions even more attractive by scrapping the 55% death duty tax currently levied on your pension pot after you die. This leaves even less reason to buy an annuity.
Let’s examine the new SIPP first of all.
SIPP - Advantages
ISA - Advantages
ISA versus SIPP: where should you invest?
As is the case with all these questions, it depends on your own personal circumstances. You might think this question is most relevant to those nearing retirement, but it is also an important decision for younger investors.
Consider the following example:
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 to 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 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, no matter which vehicle you use. For those still in doubt, I would encourage you to read my previous article 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 lump sum when you draw down, 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 draw down 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.
I will also add one important caveat: 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.
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. Chelsea has recently launched the Cofunds SIPP, via the Chelsea FundStore, a low-cost, execution-only product designed to make investing in a pension as simple as possible. Any decision you make should be carefully considered.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. James' views are his own and do not constitute financial advice.
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