Note: This post was first published in July 2020 and subsequently updated in October 2021
When I first moved to the UK about ten years ago, I remember being mightily confused by the concept of a self-invested personal pension, also known as a SIPP.
I ended up parking my mental questions on the topic when I realized that as a corporate employee, I was eligible for a workplace pension, one of the most powerful wealth-building tools in the world.
That being said, there are many people out there who don’t qualify for a workplace pension.
If you are one of them, a SIPP should rank very highly, if not at the very top, of your list of weapons of wealth accumulation.
So perhaps it isn’t surprising that over the past few months, I’ve received numerous inbounds via email and blog comments, asking me to spend a bit more time covering SIPPs.
With today’s post, I hope to clear up some of the confusion around the topic – and to explain how you can use a SIPP to grow that nest egg of yours.
To begin with, a few basic definitions are in order.
Self Invested Personal Pension Explained
At its most fundamental level, it’s quite simple:
A SIPP is just like a workplace pension – without the employer match.
Yes, there are some other nuances, but this is the critical difference. Which conveniently brings us to the next big point to remember:
You will always be better off in a workplace pension than a SIPP – courtesy of that very same employer match.
To see why, just have a look at my favourite table showing how workplace pension contributions lift your net worth:
And here is one showing the impact of the same contribution made through a SIPP:
Clearly, there’s a meaningful difference in your net wealth creation across every single tax bracket. In other words, you don’t say no to free money.
Now, this is obviously a moot point for most people. If you haven’t got access to a workplace pension, you don’t get to benefit, right?
Well, it’s not that simple. On multiple occasions, I’ve heard of people opting out of workplace pensions (or keeping their contributions to a bare minimum), because they aren’t happy with their employer’s pension provider.
Best Of Both Worlds
I have A LOT of sympathy for the sentiment above.
Sure, the asset management industry has come a long way – mostly a function of a surprisingly decent job done by the regulators.
That being said, we are not in the clear yet – and so you must watch out like a hawk to avoid getting ripped off by your workplace pension provider.
And while there are plenty of strategies to protect your hard-earned money, opting out of your contributions should not be one of them.
Instead, there’s an option not many people know of our use. It’s called transferring your workplace pension to a SIPP.
Yes, it’s possible (in the vast majority of cases). No, you don’t need to wait until you change jobs.
Once you’ve gotten that employer match and the money has been deposited into your workplace pension account, you can go ahead and transfer it out to a SIPP account.
It is true that some providers will only allow a transfer out once a year. Even then, getting the employer match is totally worth it.
With that, let’s go back to the topic at hand and see how a SIPP stacks up versus other tax-efficient investment vehicles.
Self Invested Personal Pension vs ISA: Which Is Best?
If you are contemplating using a SIPP, you should keep in mind some interesting implications for your investing strategy.
Firstly, due to the tax break, a SIPP is highly likely to beat an ISA.
Similar to workplace pensions, you don’t get to access your money until you are 55 (rising to 57 in 2028 and possibly even higher in the future).
And when you do get to access your SIPP, you will only be able to take 25% of it as a tax-free lump sum. The other 75% will be taxed as income.
But assuming your tax rate in retirement is lower than it is today (as is the case with most people), you are better off in a SIPP.
What About A SIPP vs A Lifetime ISA?
This is an interesting one with a few nuances.
If you are a basic rate taxpayer, a Lifetime ISA will always beat a SIPP.
Have another look at the SIPP table below:
The way the numbers work, a 20% tax break works out to a 25% uplift on the money a basic rate taxpayer contributes to a SIPP.
Well, guess what – that’s precisely the government bonus you get on your Lifetime ISA contributions. Except, of course, any money in a LISA is completely tax-free on the way out, whereas a SIPP will likely generate some form of a tax bill on the way out.
In contrast, higher-rate or additional-rate taxpayers will always be better off in a SIPP.
In addition, here are some other considerations to keep in mind:
You can only withdraw from your Lifetime ISA upon turning 60. At the moment, you can access your private pensions (either workplace or a SIPP), a few years prior to hitting that golden age.
Importantly, you can only contribute to your Lifetime ISA between the ages of 18 and 50 (and that’s only if you opened an account before you turned 40).
There are no restrictions of that sort in a SIPP.
Using a LISA will only allow you to contribute £4k a year (you get a maximum £1k bonus on top).
On a headline basis, SIPP contributions are capped by the lower of £40k or your annual earnings. That being said, you can carry forward unused contribution room for three years.
You can also invest in a SIPP in years when you’ve got no income. Pay in £2,880 per tax year – and get a £720 top-up from the government to the tune of £3,600 in total.
Using A Self Invested Personal Pension To Invest In Property
Every once in a while, I come across an article that claims it is possible to put your buy-to-let properties into your SIPP.
No need to worry about interest tax deductions – or any taxes for that matter. Hey ho!
Unfortunately, the reality is more convoluted than that.
Yes, you can use a SIPP to invest in property funds, but that’s very different than using it to invest in that two-bed flat out in Essex (if you still wanted to do that, given how the UK government has treated BTL investors recently).
That’s where it ends, if you happen to be a self-employed freelancer taking advantage of a third-party SIPP platform.
However, as one of this blog’s awesome readers pointed it in the comments below, it gets much easier if you happen to run your own company.
As it happens, many folks who take advantage of SIPPs do just that.
The corporation makes a contribution to the SIPP on the behalf of the employee.
The company that administers the SIPP then uses the money as it sees fit – which potentially includes acquisition of property.
Gravy On Top
For those who run their own company, there’s another very important tax benefit: corporation tax savings.
The contribution that the corporation makes into an employer’s SIPP vehicle is tax deductible. As such, a £40k contribution at a 19% corporate tax rate results in £7,600 tax saving.
And given the option to carry forward unused pension room, the maximum contribution could be up to £120k. In other words, a nifty way to minimize taxes in a bumper year, all while securing the owner’s financial future.
If that isn’t enough reason to read up on the most boring subject in the world, then I don’t know what is!
And now, let’s get ready for some FIRE fast food.
The Fastest Way To Save £100k
The graph below compares the time it will take to save your first £100k if you use a SIPP as opposed to an ISA or a LISA.
As you can see, for a basic-rate taxpayer, the headline numbers are the same whether you use a Lifetime ISA or a SIPP (until you get to taxes on withdrawals).
The other obvious observation is that if you compare the numbers for a SIPP versus a workplace pension in the original post, the employer match does go a long way in accelerating your wealth-building journey.
But there’s no need to get disappointed, because things get rather easier from there onwards.
Here’s how long it would take to save the second £100k.
Guess what – the gap is shrinking. And on a relative basis, it shrinks even more if you were to set your sights on that lofty goal of £1m:
Revisiting The Self Invested Personal Pension vs ISA Debate
If you are contemplating early retirement, using a SIPP will also affect the way you should think about balancing off your SIPP vs ISA investments.
Play around with the numbers to zero in on the right strategy for you.
A few other things come to mind.
The first one is that with a workplace pension, you typically get the right level of tax relief automatically, regardless of your tax bracket.
It’s slightly different with a SIPP. For basic-rate taxpayers, the government will make an automatic adjustment.
Higher or additional-rate payers will need to claim the extra tax relief separately, usually through the year-end tax return.
Then there’s the salary sacrifice. The construct means an extra boost for salaried employees in the form of breaks on NI contributions.
However, most people opting for a SIPP wouldn’t have NI contributions to begin with, hence the playing field is actually pretty even.
At the end of the day, there’s nothing complicated about a self invested personal pension.
Know the nuances, pick a strategy that’s right for you – and you’ll be well on your way.
As always, thank you for reading – and happy investing!
About Banker On Fire
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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
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