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ISA, ISA, ISA. In the runup to the annual April contribution deadline for ISAs, it is easy to see why some investors forget all about Self-Invested Personal Pensions (SIPPs).
In reality, though, ISAs and SIPPs are both ways for investors to invest money in the stock market (among other options).
Here I want to look at one positive and one negative aspect of both.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
The SIPP usually offers a bigger annual contribution allowance
How much someone can put into an ISA in a given tax year depends on some personal details about them (such as age). It also depends on what sort of ISA or ISAs they want to contribute to.
As a general rule, the typical adult investor is allowed to put £20,000 per tax year into their ISAs. So, if someone focused just on their Stocks and Shares ISA, they could put in £20,000 – but not a penny more.
By contrast, the typical SIPP holder can put in more than that in a single tax year. On top of that, they may be able to carry over unused allowances from previous years. That is never possible with an ISA.
The exact SIPP contribution allowance depends on various factors: the annual contribution limit is for all their private pension contributions and the SIPP may only be one of those.
In general, though, the annual contribution limit for the SIPP will often be substantially higher than for the Stocks and Shares ISA.
The good news is that an investor could use both. So, for example, if they have reached their ISA contribution allowance, they may have unused allowance left for their SIPP.
Money in the ISA’s not locked up
Now we come to what I see as an advantage of the ISA — but disadvantage of the SIPP.
Once an investor puts money into their SIPP, they cannot touch it until a certain age (currently 55). Even at that point there are rules about how it can be used.
By contrast, a Stocks and Shares ISA is more flexible. The investor can pull their money out at any age, at will.
ISA capital gains and dividends are tax free
The SIPP allows up to a quarter of the total holding by valuation (up to a defined limit) to be drawn down tax free at 55. The rest will typically be taxable upon withdrawal.
By contrast, all capital gains and dividends that accumulate inside an ISA are tax free.
One share I own in my SIPP is Diageo (LSE: DGE). A recent shock dividend cut means that I will be earning less passive income from it than I was before.
In my ISA, I might choose to withdraw dividends as cash. In my SIPP I am forced at my age to leave them inside the SIPP wrapper. That does not bother me for my Diageo holding, given the modest forward yield.
As a long-term investor, leaving Diageo shares in my SIPP for years suits me fine. The price has declined 51% in five years, anyway: I am sitting on a capital loss, not gain.
The dividend cut made me angry. For now, however, I still think the current share price overemphasises the risk to revenues of declining alcohol consumption. I believe it underrates the value of Diageo’s storied brands like Johnnie Walker and its unique production facilities.
So I plan to hang onto my shares.
