Saving for the Future
With pensions becoming ever more precarious, judicious use of ISAs and SIPPs may hold a solution
Article by Tom Anderson
ISAs and SIPPs are ‘tax wrappers’ which means that whatever you hold within them is not liable for taxation. Governments are getting ever more keen to maximise their tax revenues, which means that you suffer capital gains tax if you make a profit, and income tax if you receive dividends from an ongoing investment. There are some allowances but there is no way of avoiding tax; if you are a UK-resident, or have assets in the UK, you owe tax.
Many people are starting to realise that governments and companies are highly unlikely to pay any form of meaningful pension, and so responsibility for holding investments is falling on private investors.
Therefore, people are caught between a rock and a hard place – we have to invest because no-one else is going to pay us an income when we retire, but ownership of assets will attract taxation, which will eat away at our returns so we have less left for us in the future. This is where ISAs (Individual Savings Accounts) and SIPPs (Self-Invested Personal Pensions) can help. They allow you to hold investments without worrying about tax.
You can put up to £15,240 into an ISA each year, and whatever investments you buy are not liable for capital gains tax on realised profit or income tax on dividends received into the ISA. This means your portfolio can grow without any tax implications. You can take out cash whenever you want.
With a SIPP, you can put up to £40,000 of earned income in a year, and the government reimburses you any tax you have paid on that contribution. Whatever you buy is not liable for capital gains tax on realised profit or income tax on dividends received so your portfolio can grow without any tax, like an ISA.
Unlike an ISA, you can’t take cash out until you are 55, and this is called “crystallising” the pension or “going into drawdown”. At this point, you can decide to take up to 25 per cent of the portfolio as a tax-free lump sum. You can take the rest of the cash as well but any further withdrawals are taxed. You could take all the money, or use the remaining 75 per cent of the SIPP to generate income. This could be done by buying an annuity or keeping the investments, but any further cash that comes out of the SIPP is taxed as income.
However, neither ISAs nor SIPPs are investments as such; they are wrappers that hold investments. You still have to decide what stocks, bonds, commodities and other investments to buy, and this will involve risk because the value of what you buy may go down.
Tom is a chartered MCSI, FCA regulated investment advisor.