While market conditions continue to be challenging, particularly with issues surrounding debt in parts of the Eurozone, individuals could be forgiven for feeling helpless when it comes to constructing their portfolios.
You can't do much to prevent your investments dropping in value by 5% on a bad day in the markets, but a significant % hit from the taxman is avoidable. Step forward two tax-efficient investment wrappers: Individual Savings Accounts (ISAs) and Self Invested Personal Pensions (SIPPs).
ISAs and SIPPs are two of the UK’s best-kept secrets. Most people in the UK have heard of ISAs and SIPPs, but the fact is most people do not understand the vital role they could play in providing them and their family with a comfortable retirement.
The range of investments you can hold in ISAs and SIPPs is broadly similar, so which one you should opt for depends on your own unique circumstances.
You can contribute to an ISA and a SIPP in the same tax year, but your financial circumstances may dictate that you can only afford to invest in one of the two vehicles. So if it comes down to ISAs vs SIPPs, which should you choose?
ISAs: A tax efficient way to save
There's not much of our money that we can hide away from the prying eyes of the taxman, but an ISA is one way of doing it.
An ISA is simply a special type of savings and investment account, which is immune from tax. An ISA isn't actually an investment itself, but more of a protective wrapper into which you can put your money.
As long as your money remains in the ISA, you do not have to pay any tax on it. Once you withdraw it, or if you close the account entirely, then it becomes taxable again. In other words, you want to keep your money inside the ISA wrapper for as long as possible. Consider the idea of investing in ISAs for life.
Here are the key points to note about ISAs:
- Individual Savings Accounts (ISAs) are tax-free savings accounts.
- They were introduced in 1999 to replace PEPS and TESSAs.
- There are two types of ISA, a Stocks & Shares ISA and a Cash ISA.
- The big advantage of ISAs is that your returns are tax-free. Gains on investments held outside an ISA are liable to Income Tax or Capital Gains Tax.
- The present limit is £11,280 (2012/213 tax year) of which £5,640 can be held in cash.
Did you know ISA investing could help you net a million in tax-free income? True, some ISA investors have accounts in the tens of millions (source: FT.com 8th Oct 2010 -'Isas values rise to £1m for some investors').
SIPPs: Sheltering your retirement savings from the taxman
When it comes to saving for retirement, more and more people are choosing a SIPP.
A SIPP isn’t an investment in itself, but provides a way of investing tax efficiently, helping you save for your retirement. You could think of it as something that holds your underlying investments – a ‘wrapper’ if you like – which is how it is often described.
Surprisingly SIPPs recently celebrated their 21st birthday, yet it is only in the last five years or so that they have risen to prominence and become the preferred way for astute investors to manage their pension arrangements.
In this time, it has become progressively simpler to make pension contributions and switch between providers. Other changes have simplified things further, making contribution allowances now easier to understand and it more attractive to pass your pension to your heirs. The requirement to buy an annuity has also been removed and retirement options are considerably more flexible.
With an age of austerity in public spending upon us and private companies providing less generous pensions, individuals will increasingly be required to make their own retirement provision. SIPPs look set to serve their investors well and have a bright future as the rules have become simpler still.
We love both ISAs and SIPPs but believe ISAs have the edge. In most cases, both tax-wrappers should be used when planning for retirement. Ultimately however the decision of which one to use will depend on your financial objectives and your own personal circumstances.
The key things to remember with ISAs are they are extremely flexible and provide easier access to your money and the tax-free pot you can build is unlimited. When thinking about SIPPs, remember you get attractive tax relief upfront but you will have to wait until your 55th birthday before you can access a quarter of your account. Also remember that with SIPPs, after taking your quarter tax-free, the balance left over which is normally used to provide retirement income will be subject to income tax.
For most of us it makes sense to use both SIPPs and ISAs when saving for the future and the extent to which you use one over the other will depend on how you think your tax status will change over time and how much flexibility you need.
If you're thinking about how to save for the future, then I hope you've found this post helpful. As always, if you have any questions or thoughts on the points covered in this post, please leave a comment below or connect with us @ISACO_ on Twitter.
Please note past performance should not be used as a guide to future performance, which is not guaranteed. Investing in Funds should be considered a long-term investment. The value of the investment can go down as well as up and there is no guarantee that you will get back the amount you originally invested.
ISACO was established in 2001 by brothers Stephen and Paul Sutherland and is the first financially regulated firm to offer adventurous ISA and SIPP investors a unique personal investment service that shares on a daily basis our star-performing investor’s thoughts, personal insights and investment decisions.
Clients enjoy being informed throughout the year what ‘best of breed’ funds our premier investor currently owns, when he’s buying and when he’s moving into the safe harbour of cash – helping clients enjoy more control, manage their portfolio more effectively and benefit from the potential of outstanding long-term returns.
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