SIPP, ISA or Share Account? Which is best for retirement investing?

Let’s look at retirement investing in a Self-Invested Personal Pension (SIPP), a Stocks and Shares Individual Savings Account (ISA) and a straight forward Share Account.

To simplify, I’m assuming you pay income tax only at the basic rate of 20%. I’m also ignoring the charges each account provider makes and your tax-free Personal Allowance, which is money you can earn before paying any income tax at all.

The Self-Invested Personal Pension (SIPP)

With a  SIPP, for every £1 you pay in, the government will put the 25p in that it previously deducted from you in income tax. At first glance, that’s an awesome benefit if you view it through the lens of compounding. 

By choosing a SIPP, you gain 25% extra to compound over time, which strikes me as a good start. While sheltered in the SIPP, gains you make will be free from capital gains tax and from tax on dividend income. However, when you eventually draw the money from your SIPP in retirement, the government swoops in and collects income tax on what you take out, which appears to neutralise the tax advantage in the end.

But from the age of 55 onwards, you can draw out 25% of the value of your SIPP pot free of income tax.

Stocks and Shares ISA

With an ISA, there’s no tax relief on the way in. So for every £1 you put in, you’ll have just £1 to compound. But whatever gains you make will be free of capital gains and dividend tax and there’s no income tax to pay on the way out.

Share Account

With a straight Share Account, for every £1 you pay in, you’ll have £1 to compound. You’ll then pay tax on dividend income at 7.5% and tax on capital gains at 10%. But only after dividend income each year exceeds an allowance of £2,000, and capital gains each year exceeds an allowance of £11,700 (you only pay capital gains tax when you withdraw the money). The tax rates rise if the dividend income and capital gains when you take money out exceed the basic tax rate band (up to £46,350 a year) when added to your earned income. Nevertheless, I think those personal allowances look generous, and there’s no income tax to pay on the way out either.

How it could work out

Here’s a simple example of what your investing outcome could look like after several years for each pound you invested.

You’ll probably withdraw money from your share accounts bit by bit each year in retirement, so your personal tax allowance, your dividend allowance and your capital gains allowance will help to reduce tax bills (but your State Pension will likely use up a fair bit of your personal tax allowance).

I don’t think any of the three types of account are to be feared by people earning an average wage and investing as much as they can each year for retirement. But I think the 25% tax giveaway at 55 and over that comes with a SIPP makes that option look potentially the most attractive.