ISAs versus SIPPs
Ian Cowie asks which tax shelter is best.
Which is better: individual savings accounts (ISAs) or self-invested personal pensions (SIPPs)? Both tax shelters could soon become more valuable if Chancellor Rachel Reeves follows many of her predecessors and decides the government needs our money more than we do.
To be fair, she has a better excuse than most, now that Europe’s worst war since 1945 has taken a turn for the worse, prompting urgent calls for more defence spending. Fortunately, ISAs and SIPPs both offer annual opportunities to put our capital and income beyond the grasp of the taxman and which is better will depend on our changing needs at different times in life.
To simplify a complex comparison, these shelters for savings can be regarded as mirror images of each other. With SIPPs we get our tax relief upfront or initially; with ISAs tax freedom is enjoyed later, on the way out or withdrawals.
So, perhaps paradoxically, I would say that putting money in a pension is most attractive for younger people, provided they won’t need it back quickly. The explanation is that they stand to gain more from upfront tax relief boosting their initial investments to help build capital over long periods of time.
Setting aside costs for the sake of simplicity, most people who put £800 in a SIPP will have £1,000 working for them from day one, while high earners can achieve the same effect by putting in £600. Then compounding can work its magic to grow their wealth before tax bills fall due on most withdrawals, which are only allowed after the saver reaches 55 years of age.
To simplify a complex comparison, these shelters for savings can be regarded as mirror images of each other. With SIPPs we get our tax relief upfront or initially; with ISAs tax freedom is enjoyed later, on the way out or withdrawals.
Ian Cowie
By contrast, older people – such as your humble correspondent, skidding sideways into my seventh decade – may gain more immediately from ISAs’ ability to generate tax-free gains and income, whenever they are required. There is no minimum age or holding period before withdrawals can be made, nor any earnings-related limits on contributions, apart from the £20,000 maximum cap on annual ISA contributions.
Never mind the generalities, here’s how it has worked – and continues to work – for me in practice. More than a decade ago, I bought shares in investment trusts that aim primarily for long-term capital growth and popped them in my SIPP.
To be specific, in September 2014, I transferred shares in Polar Capital Technology (stock market ticker: PCT) from a personal pension with a paper-based broker into my online SIPP while they were trading at the equivalent of 43p, allowing for a subsequent ten-for-one stock split. Even after extreme volatility recently, they trade around 317p at the time of writing.
Similarly, Worldwide Healthcare (WWH) is another investment trust where I have been a shareholder for more than a decade. In March 2014, I transferred stock from an old-fashioned broker onto an online platform when WWH was trading at the equivalent of 135p, allowing for another ten-for-one split in July 2023. They trade around 320p at the time of writing.
In both cases, the SIPP savings shelter allowed my initial investment, boosted by upfront tax relief, to grow wealth without much being absorbed by HM Revenue & Customs. But pensions planning is a long-term business and it’s only fair to add that JPMorgan Indian (JII) did even better over the decades. Shares I bought for 63p in June 1996 became my first ten-bagger years ago and cost 906p today.
Of course, capital growth is not guaranteed because share prices can fall without warning and you might get back less than you invest. Similarly, dividends are not guaranteed and the income that shares may pay investors can be cut or cancelled without notice.
However, no fewer than 19 investment trusts have succeeded in increasing shareholders’ income every year for two decades or more. I recently invested in two of them – Alliance Witan (ALW) and F&C (FCIT) – for my grandchildren, largely because these trusts survived both World Wars and the Great Depression, plus they have raised dividends without fail for 58 and 53 years respectively.
The past is not necessarily a guide to the future. But the history of ALW and FCIT gives me some factual grounds to hope that my grandchildren will not be disappointed when they reach adulthood, Deo volente, more than 15 years hence.
For my own ISAs, I favour higher yielders including Greencoat UK Wind (UKW) and the marine leasing specialist, Tufton Assets (SHIP). The former currently pays 9.1% dividend income that has risen by an annual average of 7.6% over the last five years, while the latter yields 8%, rising by 5.7% per annum.
It’s only fair to add that the price of this high income has been low or no capital growth. I paid 145p in August 2023 for UKW shares that fetch only 114p today; and 86p in August 2021 for SHIP shares that bob along at 93p now.
This illustrates the important point that tax shelters are no substitute for investment returns. But ISAs and SIPPs have both helped me grow capital with income over many years in the past, and I hope they will continue to do so, whatever happens in an uncertain future.
Ian Cowie
Ian writes a weekly column about his stock market investments for The Sunday Times, which he began in 2013. He was personal finance editor of The Daily Telegraph for more than 20 years, after joining as a city reporter in 1986. He writes regularly for the AIC.
