It can be confusing knowing the most suitable way to invest over the long term, for example, as part of retirement planning. There are specialist pension products like Self-Invested Personal Pensions (SIPPs). But many investors tend to focus more on what they already know: a Stocks and Shares ISA.
When it comes to pension planning, both a SIPP and an ISA can have some pros and cons.
There’s no free money in an ISA
Both vehicles can help someone to accumulate capital gains and dividends in a tax-efficient manner.
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.
But an ISA does not involve any ‘free money’ – at least not from the government. An ISA provider may have a promotion that offers a cash incentive to use them.
Believe it or not, a SIPP does offer free money. Specifically, the government offers tax relief for income tax payers contributing to their SIPP.
So, it is essentially the Exchequer giving you with one hand what they already took away with the other.
Still, that can be a substantial bonus. For example, a basic rate taxpayer who puts £8,000 into their SIPP will have £10,000 to invest thanks to the tax relief. Higher and additional rate taxpayers will find the tax relief even more lucrative.
SIPPs have some important constraints
So, why do people use an ISA over a SIPP given the free money a SIPP can involve?
One big consideration is what happens to the money after it is in the vehicle.
With an ISA, someone can decide to take the money (or some of it) out at any time. There may be several reasons why someone chooses to take money out. For example, they have an unexpected expense like higher school fees due to tax changes, or a medical emergency.
By contrast, the SIPP is designed in a way that is meant to keep people focussed on their retirement finances even when other emergencies pop up along the way.
So they cannot take a penny out of the SIPP until they are 55. Even then, only a portion of it can be withdrawn tax-free. For withdrawals over that limit, capital gains tax rules would apply.
That different tax treatment could make a SIPP less attractive, when compared to the absence of tax on capital gains made inside an ISA then withdrawn. The lack of flexibility about withdrawals before 55 may not suit some investors either.
Here’s my approach
I see benefits in both vehicles, as well as less attractive features, so I have both a SIPP and a Stocks and Shares ISA.
As a long-term investor, I try to focus on shares I think have potential for the coming decades. One I think currently merits consideration is Pets at Home (LSE: PETS).
Its share price has fallen by a fifth over the past year and now stands at just 11 times earnings.
Personally, I think pet lovers will keep spending money on their animals even when consumer spending more broadly is squeezed.
There are risks: the share price fall reflects Pets at Home’s weak retail performance. It has been trying to improve that but there is a risk that the wrong stock selection or uncompetitive pricing could still cost it sales.
The company has a large and growing group of vet practices to help offset that weakness – and a dividend yield of 7%.
