Sipp vs lisa + isa

(James White) #1

I have been investigating what I should do regarding my retirement planning (i actually enjoy this for some odd reason… super exciting go me).

I’m 35 and plan to retire around 60 (hahahaha, you have to dream) so what should I do with my monthly savings?? Background is that I have an ISA with some stock primarily focused on long-term dividend shares spread over 20 companies mainly larger ones with ~4% div yield. Options I am considering now are max out a LISA (thanks government for the top up) for the next 4 years until I’m 40 or contribute to a SIPP (currently standard rate taxpayer with small company matched pension) again thanks government for the top up.

Now the question comes LISA is great as there is no tax to pay on “draw down” but with the SIPP there is, minus the tax-free income allowance, and 25% lump sum, also possible to start drawing down SIPP at 55 (57 soon)

Should add that i aim to save about 10 - 12k per year so anything over the 4k LISA allowance would go into a standard ISA.

So what’s the optimal balance? How can i work out what to put where to minimize by tax in 25 years time, understand that this is probably all completely redundant as the tax policy will have changed a million times by the time i retire and we will all be living on Mars.

Any discussion and ideas on what other are doing / not doing would be great :slight_smile:
Cheers all

(Vladislav Kozub) #2

LISA is a very interesting product but criticised for its uncertainty that leads to penalisation of less aware users. There is a possibility of LISA being scrapped based on few MPs’ sentiments (although that is only an assumption).

However, while it exists, it is worthy if you definitely will not need that money until you are 57. But only if you keep it in a S&S LISA account and get some index fund or ETF(s) with low commissions. Cash LISA is not worth it because the interest is low (despite slowly increasing) and 25% growth in one year with not much more for 22 years (when you will be able to draw this down) is not going to outperform regular S&S ISA.

(Harry) #3

Great topic!

Ok so depends on personal circumstances (and obviously this is not advice etc etc). You can invest £20k across the ISA wrapper (£21k after your LISA bonus) whereas currently if you earn less than £150k you can put £40k into a pension (unless you earn less than £40k, then it’s limited to your income i.e earn £35k you can put £35k into a pension). £40k is known as the annual allowance.

The pension wrapper is still most beneficial from a tax perspective. The amount you put in within the annual allowance is ‘grossed up by the government’, and the amount you contribute is not counted for income tax I.e. you personally contribute £5k to your pension, £5k is ‘removed’ from your income from HMRC perspective.

Both pension and ISA are free of income and capital gains tax within the wrapper. When you take money from your ISA/LISA there’s no tax either, but with a pension you can have 25% free of tax, then you pay income tax on the rest.

Basically a mixture of both - more beneficial if you’re a higher earner to pay into your pension. But you can access ISA money if needed in an emergency!

(Harry) #4

I agree if you’re investing long term, but a LISA can be taken to help a first time house purchase. If you’re relying on your LISA for that then cash may be a better option if it’s within 5 years or so.

(Vladislav Kozub) #5

Not arguing with that at all, for that purpose, there is HTB ISA as well, and it does not penalise early withdrawals as far as I am concerned.

(Kenny Grant) #6

I think another important factor to consider with pensions is that they are governed by arbitrary and frequently changing rules, so it’s important to be cognisant of that when putting money in. You don’t control when you can take money out (unlike an ISA), or the terms of that withdrawal (age, annuities, final salary etc) - the rules will constantly change as you age, not always for the better. As you point out, tax is given back at the point of saving, but then you are taxed on any pension income when you retire (if you earn enough). So it’s a complicated picture for pensions, and ISAs are probably easier to understand and easier to get out of if/when the rules change and you want to put the money elsewhere. Personally I trust ISAs more than pensions but it is good to have both, particularly if your employer contributes anything significant.

So as you say a mix of both approaches is probably good for most people, as it provides the most flexibility, and it’s good to have a rainy day fund as well as money locked away for retirement. What that mix is depends a lot on personal circumstances and your judgement of how risky pensions are. What we can say with certainty is that keeping savings in cash is not a good bet long term (though it can be useful short term), so a mix of assets are your best bet, whatever wrappers you choose to put them in.

(Harry) #7

ISA/LISA are also tax wrappers and are open to change as much as pensions. I agree pensions are viewed as more complicated but most new pensions are more simplified. You do also govern the timing of withdrawals from your pension - when Freetrade have a SIPP for example you can decide when you take your money out, you aren’t forced to take it at any age.

Another benefit of a pension wrapper is that it’s free of inheritance tax, so you can pass it down to your beneficiaries without paying 40% IHT.

(James White) #8

Thanks for the input Vlad, totally agree and probably should have stated that it would be a S&S LISA not a cash one as that is pointless with rates so low.

My approach for the investments in either the SIPP or LISA would be the same, I’m planning to select 4 or 5 higher yield - 3 - 5% ETF’s to invest in monthly and let them do their thing (plus reinvest the dividends) until I retire when I then plan to only draw down the dividends and leave the capital alone if possible.

(Vladislav Kozub) #9

It will be locked until the age of 55-57 regardless of the provider, unless in the case of death or terminal illness.

When it comes to pensions and SIPPs, it is vital to only contribute the amounts you will sustain yourself without until that age.

(James White) #10

Excellent point on the IHT!

(Harry) #11

Yes good clarification! After 55-57 you can decide how much. Important distinction.

(Kenny Grant) #12

Yes and no. They are definitely subject to change just like pensions, but this would be politically difficult compared with meddling yet again with pension rules, and crucially ISAs let you take money out tax free at any point. Of course any rules can change, ISAs may disappear, but I think ISAs are less liable to change fo this reason - their strength is the simple rules (harder for politicians to meddle) and ease of access, and if they change you can move the money, unlike pensions.

But a mix of both is good, pensions can be much better, particularly with employer contributions.

(Vladislav Kozub) #13

Indeed. Also, for higher rate taxpayers, they will be exposed to significant (40%) tax refunds into SIPPs that will boost the growth of their holdings.

If a person contributes £60 from their salary, they get further £40 as a tax refund (assuming higher rate taxpayer), and £100 is matched by the employer (assuming 1:1 matching).

That way you have had 233% growth on Day 1, which will have a significant long-term growth magnitude.

To be more realistic, let’s assume basic rate taxpayer and employer matching 60% of the contribution (next year they will be obliged to pay 3% of the employee’s salary if an employee himself pays 5%):

You pay £80, state adds £20, employer adds £60. Even in the worst case scenario such as this, pension contribution is double of take-home figure, hence the magnitude of growth in comparison to an ISA.

Whilst this is right, it has own caveats. For example, if a pension holder dies before the age of 75 - no tax to the beneficiaries.

If after 75 (which nowadays is rather a norm), you can either choose to pay 45% tax on a lump sum (more penal than IHT!) or inherit and pay at your respective income tax rates.

(James White) #14

Having thought about financial planning for a few years I’ve built up a little rainy day fund in a simple straight forward old fashioned bog standard ISA already. I also am fortunate enough to have got on the property ladder before things went completely bonkers. I’m happy with that so locking in until retirement is ok for me at the moment (stuff can change of course).

You can only plan with the current rules in mind i guess if you tried to preempt what the government might do for the next 25 years i suspect we would all have a nervous break down before we got there.

My current thinking is to stuff the £4k in a LISA for the next 4 years (Freetrade please have LISA’s available for April next year :slight_smile: ) get that topped up to 5k a year, then anything i have left i.e. ~£8k for the year i will stick in a SIPP. Then once i get to 40 i will stick doing something similar but with a Standard ISA. Seems like a good balance.

On the IHT point its also possible to plan around it by putting assets into trusts enough years before you die.

(James White) #15

Does anyone know what you can do with the Dividends you receive in a LISA after the age 40 or 50? I.e. if I Max out the 4k + 1k from government, can i reinvest the dividends or do they just have to sit there doing nothing?

(Harry) #16

You can continue paying into the LISA until you’re 50, you can only set it up if you’re under 40. In terms of dividends, I imagine you will be able to reinvest them yes because it isn’t counted as new money into the wrapper :slight_smile:

(James White) #17

Plan would be to max it out within the year for each year up to 40 then hopefully like you i would be able to reinvest the div’s until draw down.