Should you invest in a pension or an ISA? Is there a decisive answer to the eternal SIPPs vs ISAs question?

Well… almost. We can make three immediate statements that provide clear direction – although the decision tree gets pretty thorny after that:

If you hope to live off your investments before your minimum pension age1 then a stocks and shares ISA is the clear winner. 

Employer pension contributions are an unbeatable leg up. Take them, take them, take them. It’s free money, unless you plan on dying a rock ‘n’ roll death before age 55. (Pro tip: almost nobody does.)

If you’re self-employed, or have hoovered up your employer’s match, then much depends if you’re contributing to your SIPP (or other pension type) at the higher-rate of income tax or the basic rate:

Paying higher-rate tax? Then prioritise your pension accounts over ISAs.

Paying basic-rate tax? Then the choice between a SIPP and a Lifetime ISA (LISA) is finely poised. We’ll delve deeper into this below.  

If you’re a young basic-rate taxpayer who won’t retire until State Pension age, then an ISA may beat a SIPP in certain scenarios. Again, we’ll explain below. 

The Kong-sized caveat to all this is that future changes to the tax system may move the SIPP vs ISA goalposts. 

You can have it all

Tax-strategy diversification can help you deal with the uncertainty. This simply involves diversifying your tax shelters, irrespective of their current pecking order.

Spreading your savings across your tax shelters makes the most sense for young people for whom retirement is decades away. But the technique is worth everyone considering, because SIPPs and ISAs hedge against different tax risks. We’ll come back to that.

With those broad ISA vs SIPP principles established, I’ll take you through the reasons why in the least painful way I can. Though keep your aspirin on standby. 

To set the scene, let’s first recap what ISAs and SIPPs have in common, and what sets them apart. 

Terminology intermission: I mostly talk about SIPPs in this article but the conclusions apply equally well to other defined contribution (DC) pensions, such as Nest-style auto-enrollment Master Trust Pensions. I’ll use the term ISAs to refer to all ISA types, except for the LISA. I’ll mention the LISA when its special features alter the SIPP vs ISA comparison.

SIPPs vs ISAs: these things are the same

SIPP or ISA? There’s nothing between them on the following counts:

Tax shelter / feature
SIPP
Stocks and shares ISA

No tax on dividends
Yes
Yes

No tax on interest
Yes
Yes

No tax on capital gains
Yes
Yes

Invest in funds, ETFs, bonds, shares
Yes
Yes

Ceiling on lifetime tax-free income
No
No

Versions for children
Yes
Yes

SIPPs vs ISAs: these things are different

ISA or SIPP? Well, on the other hand…

Tax shelter / feature
SIPP
Stocks and shares ISA

Free of income tax on withdrawals
No
Yes

Income tax relief on contributions
Yes
No

Tax relief on National Insurance
Yes, with salary sacrifice
No

25% tax-free cash on withdrawal
Yes, up to £268,275
N/A

Access anytime
No
Yes

Annual limit on contributions
£60,000
£20,000

Employer contributions
Yes
No

Inheritance tax exempt
Yes
If passed to spouse,
otherwise no

As you can see, a SIPP gathers more ‘Yes’ votes than an ISA, and those advantages stack up. 

Remember that ISAs are superior to SIPPs when access to your money before the normal minimum pension age is your priority. 

However, the various tax breaks on offer make SIPPs the best option for the bulk of most people’s retirement savings. 

LISAs are a different kettle of tax wrapper, though. The dream combination of tax relief and tax-free withdrawals make LISAs an attractive option for basic-rate taxpayers vs pensions – under some circumstances. 

The devil is in the detail and we’ll dance with him shortly. Before that, let’s talk tax-strategy diversification.

Tax-strategy diversification in retirement planning

Tax-strategy diversification for UK investors means spreading your retirement savings between your LISA, ISA, and SIPP accounts. It’s partly a defence against adverse changes to the tax system in the future. 

The concept is analysed in a US research paper called Tax Uncertainty and Retirement Savings Diversification by Brown et al.

The paper examines the impact of tax code changes upon the traditional IRA and the Roth IRA. These two American tax shelters are analogues of our SIPP and ISA, respectively. 

The authors make several key observations. So I’ve translated their US tax-shelter language directly into their UK equivalents, as follows…

SIPPs are negatively affected by income tax hikes in the future, and are positively affected by income tax falls. 

For example, if you get tax relief at 20% but are taxed on retirement withdrawals at 22% then that’s a blow against pensions. 

The reverse is true for ISAs. They’re taxed upfront so enable you to lock in your income tax rate now. This is an advantage for ISAs vs SIPPs if tax rates rise in your retirement. 

For example, you win if you took a 20% tax hit on the salary that funds your ISA contributions today, but withdraw tax-free in the future – when the basic rate of tax has risen above 20%.  

SIPPs are a hedge against poor pension performance. In other words, if your investments are hit by a terrible sequence of returns then more of your withdrawals will be taxed at a lower tax bracket. This offsets some of the damage wreaked by bad luck, especially if you banked higher-rate tax reliefs when you were working. 

The long game

The whole paper is well worth a read. But the following quotes provide particular insight on how future tax changes could boost or hobble SIPPs and ISAs for different demographics.

Future tax rates are more uncertain over longer retirement horizons. Our analysis of historical tax changes also suggests that the rates associated with higher incomes are more variable.

The paper’s authors found that income tax rates were much more volatile for high earners going back to 1913.

So it’s worth remembering amid the current gloom that the tax burden isn’t a one-way street. Income tax-rates fell dramatically in both the US and the UK in the 1980s. Higher earners also enjoyed more recent cuts in America. 

As a result, the highest tax-risk exposures will occur among younger investors with sufficient traditional account [SIPP] savings to produce taxable income in retirement that exhausts the lower-income brackets. Young, high-income investors who are likely to meet these criteria can manage their exposure to tax-schedule uncertainty by investing a portion of their wealth in Roth [for us, ISA] accounts.

High-income investors increase their allocations to Roth [ISA] accounts when faced with uncertainty about future tax rates. At these income levels, reducing consumption risk in retirement by locking in tax rates today is more valuable than realizing a potentially lower tax bracket in the future.

Young, higher-earners are the most susceptible to steep future tax rises, according to this analysis. Thus tax-strategy diversification implies they should hedge against that possible fate by ploughing a significant portion of today’s income into ISAs. That’s because the danger with SIPPs is that future withdrawals may be made at tax rates that are higher than the reliefs on offer today. 

I’d caution, though, that the biggest SIPP vs ISA gains come from taking higher rates of tax relief on pensions that are subsequently taxed at a retiree’s much lower income tax rate. UK income taxes would have to soar in the future to negate this advantage. 

On the other hand, here’s a reason to invest in pensions that most of us would rather not think about: 

Investors with sufficiently high current income must pay the top tax rate in the current period, however, such that the traditional [SIPP] account is preferable for higher-income investors who may end up in a lower tax bracket if the stock market performs poorly.

The case for a bit of both

Ultimately, the paper comes to a conclusion that I suspect many investors reach using their gut:

The optimal asset location policy for most households involves diversifying between traditional [SIPP] and Roth [ISA] vehicles.

Spreading your bets makes sense (as ever), especially when retirement is still a dim and distant prospect. 

But that said, do bear in mind this is a US-focused study. Their income tax bands are more nuanced than ours.

In contrast, our SIPPs benefit from a massive cliff-edge if you enjoy higher-rate tax relief when you pay in but your retirement income falls mostly in the 0-20% band. 

This feature of the UK tax system tilts the playing field heavily in favour of pensions vs ISAs, as we’ll see.  

ISA vs SIPP: when it doesn’t matter

You’re taxed upfront on money that goes into your ISA, but your withdrawals are tax-free. 

SIPPs work the other way around. You pay less tax on contributions, but are subject to tax on money taken out. Thus UK pension vehicles can be thought of as tax-deferred accounts. 

ISAs vs SIPPs is a dead heat when the tax deducted from your ISA contributions matches the tax you pay on pension withdrawals. 

The amount of cash you can take out of each account is exactly the same in this situation, as shown in the following example:

Account
Gross income
Net after tax
After tax relief
Withdrawal

ISA
£100
£80
£80
£80

SIPP
£100
£80
£100
£80

The example tracks the value of £100 through the tax shelter journey, from contribution to withdrawal.

Think of it as comparing each £100 that you could choose to put in either your ISA or SIPP. 

Gross income is earned before tax. 
Net after tax is the amount left in your account after HMRC takes its bite. 
After tax relief is the value of your savings after any rebates. 
Withdrawal is what’s left of your original £100 once taken in retirement (based on current tax rates and ignoring investment returns because they’re ISA vs SIPP neutral).  

A previous post of ours walks you through the underlying SIPP vs ISA maths. 

But just to be clear, pensions always win when an employer contribution match is on the table. Pound-for-pound that doubles your money. Not taking the match is sort of like taking a pay cut. 

Same difference

Employer contributions notwithstanding, the example above shows that the tax-saving powers of an ISA or a SIPP are evenly matched when:

You’re taxed at 20% on the ISA cash you put in, and

You’re taxed at 20% on the SIPP cash you withdraw

The amount of income you can take from each vehicle is the same, if the tax rates are equal. The order of tax and tax relief makes no difference to your investment returns, as The Investor has previously shown. 

If both accounts gain, for example, 5% a year, then your SIPP’s balance will be larger than your ISA’s because there’s a bigger sum of money to grow after tax relief. 

But the SIPP’s advantage is cancelled out by tax on withdrawal. Hence the Withdrawal value is identical for both accounts in this scenario. 

If that’s the case for you then we need to head into an ISAs vs SIPPs tie-breaker situation.

ISAs vs SIPPs: tie-breaker situation

Priority
ISA
SIPP

Access before pension age
Yes
No

Inheritance tax benefit
Spouse
Anyone

Means-testing / bankruptcy advantage
No
Yes

Tax-strategy diversification 
Use
both

Personally, if I was many years from retirement, I’d favour the accessibility of ISAs as a handy backstop. Just in case life took an unpleasant turn. 

Some of you on loftier incomes may prioritise inheritance tax (IHT) planning. Monevator contributor Finumus came up with a particularly extreme – but seemingly legal – IHT avoidance wheeze using SIPPs. 

However, the wisdom of tax-strategy diversification still suggests splitting your savings between both vehicles. 

SIPPs vs ISAs: back in the real world

Because most people will be taxed at a lower rate of tax as retirees than they are as worker bees2, in practice pensions usually beat ISAs for retirement purposes.

Albeit LISAs are the wild card that can disrupt the SIPP vs ISA hierarchy. 

Much depends on:

How much 0% taxed cash3 your SIPP ultimately provides as a percentage of your retirement income.  
Whether your SIPP income is taxed at a lower bracket in retirement relative to the tax relief you snaffled while working. 

To unpick the complexity, I’ll try to find the best-fit tax shelters for most people by running through some common retirement income scenarios.

And I’ll account for variations in individual circumstances by looking at key breakpoints that alter the ISA vs SIPP rankings. 

Breakpoint 1: the tax shelter types available

I tested the tax efficiency of four accounts that are useful in retirement:

Salary sacrifice SIPP. This wrapper enables basic-rate employees to legitimately avoid 32% tax (20% + 12% NICs) while higher-rate employees avoid 42% tax (40% + 2% NICs)

SIPP. A standard pension account provides tax relief at the 20% and 40% rates but you still pay national insurance contributions (NICs)

Stocks and shares ISAs can deliver the investment growth needed for retirement. 

As can LISAs which also accept investments. 

Breakpoint 2: retirement income levels and stealth taxes

I’ve examined three retirement income levels that align with the research published in the Retirement Living Standards report. 

These three tiers equate to a Minimum, Moderate, and Comfortable living standard in retirement. 

However, I’ve adjusted the incomes to account for our current era of stealth taxes. 

The UK’s tax thresholds are frozen until April 2028. That is a tax hike by any other name. 

The Office for Budget Responsibility estimates this manoeuvre amounts to increasing the basic rate of income tax from 20% to 24%. 

Rising rates of tax disadvantage pensions vs ISAs as noted earlier. So I’ve inflated the three retirement income levels by my CPI guesstimate up to 2028.4 This increased income requirement models SIPP withdrawals losing more to tax, as inflation erodes the lower brackets. 

I assume that the tax thresholds rise with inflation after April 2028, as they should. 

Breakpoint 3: how you use your personal allowance

The less your SIPP income is taxed in retirement, the better SIPPs do versus ISAs.   

If you retire at age 55 and don’t receive a State Pension until age 67 then your SIPP’s tax performance improves – especially at lower retirement incomes – because a significant chunk falls into your personal allowance. 

But the SIPP advantage contracts if your personal allowance is mopped up by the State Pension, defined benefit pensions, or by any other income. 

Indeed, with the personal allowance frozen and the Triple Lock intact, the full State Pension could grow large enough to entirely fill the 0% income tax band by April 2028, or soon thereafter. 

I’ve used that assumption in the examples below to guide anyone who thinks they’ll retire at State Pension age, or with a substantial source of alternative income. 

Even if you retire early, the State Pension will arrive around ten years after your normal minimum pension age, after April 2028. 

I account for this by modelling a 40-year retirement journey. This sees SIPP income cease to benefit from the personal allowance after the first decade. 

Breakpoint 4: the fate of 25% tax-free cash

UK pensions are boosted by another blessed benefit. That’s the 25% tax-free cash that can be taken as a lump sum (PCLS) or in ongoing chunks (UFPLS). 

Before the Lifetime Allowance was abolished, the tax-free sum used to automatically reduce a basic-rate payers overall income tax burden from 20% to 15%. 

But that can no longer be taken for granted – because the 25% tax-free cash allowance is now capped at £268,275. 

It sounds a lot as of today, but the Chancellor has said the limit is frozen. 

Frozen until April 2028 – after which it rises with inflation?

Frozen forever? In which case inflation will eventually swallow it like light quaffed by a black hole. 

It’s not clear, so I’ve tested both scenarios. 

The first scenario is relevant to near-term retirees who can assume their tax-free cash allowance will retain most of its current value when they retire. Especially if they’re at the Minimal to Moderate income levels and inflation is tamed again (which helps if the cap doesn’t rise in future years). 

The second scenario may make sense if you’re three or four decades from retirement, and the cap remains frozen in time while inflation crushes it. 

Final preamble point: I’ve used UK income tax rates – though the results will still be relevant to most Scottish income taxpayers, with minor variations. 

Right, at last, let’s get on with the key ISA vs SIPP examples.

SIPPs vs ISAs: £15,480 Minimum annual retirement income

SIPP contributions are made at the basic income tax rate in this scenario. And the 25% tax-free cash cap is not reached during a 40-year retirement.

Ranking
PA5 intact
Retire on State Pension
40-yr retirement

1.
Salary sacrifice
LISA / Salary sacrifice
Salary sacrifice

2.
LISA / SIPP
–
LISA

3.
–
SIPP
SIPP

4.
ISA
ISA
ISA

PA intact = SIPP income benefits from the 0% personal allowance (PA)

Retire on State Pension = SIPP income does not benefit from the personal allowance

40-yr retirement = The ranking for a 40-year retirement journey that relies on SIPP income for the first decade, while the State Pension absorbs the PA thereafter. 25% tax-free cash may run out at some stage. (Though not at the Minimum income level) 

The headline is that a salary sacrifice pension wins across a 40-year retirement journey beginning about age 57. That is, the normal minimum pension age. 

But the LISA matches a salary sacrifice SIPP if you retire later with a full State Pension at age 67 (and/or a decent defined benefit pension etc). 

A normal SIPP (‘relief at source’ or ‘net pay’) lags behind a LISA overall. Standard ISAs come last. 

Despite this outcome, remember that any pension is immediately catapulted above a LISA so long as your employer matches your contributions. 

After you’ve trousered your employer’s contributions, you’re best off stuffing your LISA up to its £4,000 annual hilt on tax-strategy diversification grounds. 

LISA contributions locked in at today’s tax rates will benefit versus pensions if taxes go up in the future. 

Intriguingly, a normal SIPP only just scrapes in ahead of an ISA if you retire at State Pension age. 

In this scenario, you pocket £72.50 from a SIPP, and £68 from an ISA, for every £100 you originally contributed to each account. That’s only a 6.6% difference.

Such a slim margin suggests that diversifying between the two accounts is a sound idea. Albeit I’d still heavily favour my SIPP, given that small gains make all the difference at lower incomes. 

If the 25% tax-free cash is eliminated

Ranking
PA intact
Retire on State Pension
40-yr retirement

1.
Salary sacrifice
LISA 
LISA

2.
LISA 
Salary sacrifice
Salary sacrifice

3.
SIPP
ISA / SIPP
SIPP

4.
ISA
–
ISA

The advantage swings in favour of LISAs if the 25% tax-free cash ceases to be a factor in reducing SIPP taxation. 

For those retiring at the State Pension age, an ISA strategy even draws level with a SIPP in terms of withdrawal value: £68 a piece for every £100 contributed. 

If I really believed that the 25% tax-free cash will whither to nothing then I’d overwhelmingly favour my ISAs vs SIPPs in this scenario. 

However, I think it’s more realistic to assume that the 25% tax break will retain some residual value, even if you’re 30-40 years away from retiring.

SIPP contributions made at higher-rate taxpayer level

Ranking
PA intact
Retire on State Pension
40-yr retirement

1.
Salary sacrifice
Salary sacrifice
Salary sacrifice

2.
SIPP
SIPP
SIPP

3.
LISA
LISA
LISA

4.
ISA
ISA
ISA

Higher-rate taxpayer contributions lead to a decisive win for pensions in the SIPPs vs ISAs match-up. 

LISAs and ISAs form the bottom half of the table in this scenario and stay there. Salary sacrifice and normal SIPPs continue to beat the L/ISA gang even if the 25% tax-free cash disappears entirely – and whether you retire at the Minimum, Moderate, or Comfortable income level. 

LISAs do best SIPPs if you expect to earn around £75,000 per year in SIPP income. That’s because the tax-free cash cap is hit so quickly. 

But for those of us operating below such Olympian heights, the higher-rate tax reliefs are the sweet spot for pension contributions – because 40%-tax workers are likely to become 20%-tax retirees.

SIPPs vs ISAs: £23,300 Moderate annual retirement income

SIPP contributions are made at the basic income tax rate in this scenario. The 25% tax-free cash cap is not reached during a 40-year retirement.

Ranking
PA intact
Retire on State Pension
40-yr retirement

1.
Salary sacrifice
LISA / Salary sacrifice
Salary sacrifice

2.
LISA
–
LISA

3.
SIPP
SIPP
SIPP

4.
ISA
ISA
ISA

Salary sacrifice outcomes continue to dominate normal SIPPs. That’s because they effectively gain relief on 32% tax, instead of 20%. 

Meanwhile SIPPs only just beat ISAs across a 40-year retirement, and for those retiring at State Pension age. Narrow margins strengthen the case for tax-strategy diversification.

If the 25% tax-free cash is eliminated

Ranking
PA intact
Retire on State Pension
40-yr retirement

1.
Salary sacrifice
LISA 
LISA

2.
LISA 
Salary sacrifice
Salary sacrifice

3.
SIPP
ISA / SIPP
SIPP

4.
ISA
–
ISA

The ISA / SIPP draw occurs because the SIPP’s 20% tax relief on contributions is the same as the ISA’s 20% tax exemption on withdrawals.

The SIPP vs ISA rankings for higher-rate taxpayer contributions are the same as the Minimum income level, regardless of what happens to the 25% tax-free cash. 

SIPPs vs ISAs: £45,109 Comfortable annual retirement income

SIPP contributions are made at the basic income tax rate in this scenario. The 25% tax-free cash cap is reached after 24 years of retirement.

Ranking
PA intact
Retire on State Pension
40-yr retirement

1.
Salary sacrifice
LISA / Salary sacrifice
LISA

2.
LISA
–
Salary sacrifice

3.
SIPP
SIPP
SIPP

4.
ISA
ISA
ISA

As before, SIPPs only just beat ISAs across a 40-year retirement, and if you stop work at the State Pension age.

LISAs top the table across a 40-year retirement because the tax-free cash spigot splutters dry after 24 years. 

However, it’s possible to avoid this fate by pulling out your 25% tax-free cash as a lump sum (PCLS) before the ceiling is reached.

Ideally, you’d get it all under ISA cover as quickly as possible. Once in an ISA your money can continue to grow tax-free without limit. (That is, as if the tax-free cash cap had not been introduced.)

How doable is that? 

Sheltering your tax-free lump sum

Let’s say you retire in late March and deliberately leave that year’s ISA allowance free until then. That’s £20,000 under your tax shield straightaway. 

The tax year clock ticks on to April 6. Now you’ve got another £20,000 worth of ISA to fill with newly-minted 25% tax-free cash.  

Perhaps you also have some emergency cash standing by, an offset mortgage facility, or other cash savings?

With a bit of planning, you can use these resources to expand your flexible ISA’s elastic band in the years before your retirement date. 

Check out the ‘Flexible ISA hack to build your tax-free ISA allowance’ section in our ISA allowance post. (Hat tip to Finumus who came up with the idea.)

Double your ISA allowance numbers if you have a trustworthy significant other. 

You’ll be able to stash a bit more tax-free in General Investment Accounts, too. However, the much-shrunk dividend tax and Capital Gains Tax allowances mean that only a smidge of your subsequent returns will escape HMRC’s tractor beam. 

All the same, you’re better off being taxed at dividend and capital gains rates than income tax rates. Hence you should withdraw any 25% tax-free cash as soon you can, once you look like you’ll hit the cap. It’s better out than in. 

If the 25% tax-free cash is eliminated

Ranking
PA intact
Retire on State Pension
40-yr retirement

1.
Salary sacrifice
LISA 
LISA

2.
LISA 
Salary sacrifice
Salary sacrifice

3.
SIPP
ISA 
ISA

4.
ISA
SIPP
SIPP

Notice that a SIPP actually performs worse than an ISA in the main two scenarios. That’s because a ‘Comfortable’ income earner ends up being partially taxed at the higher-rate. This might happen to a basic-rate worker who saved into their SIPP from a young age, experienced outstanding investment performance, or suffered elevated tax rates in retirement. 

The SIPP vs ISA rankings for higher-rate taxpayer contributions are the same as the Minimum income level. 

The ranking is: Salary sacrifice SIPP, non-salary sacrifice SIPP, LISA, then finally ISA.

LISAs vs SIPPs: tie-breaker situation

There are quite a few scenarios that end in a draw between LISAs and pensions. Let’s head into the tie-breaker:

Priority
LISA
SIPP

Access before age 60
No
Yes

Can help to buy a house
Yes
No

Inheritance tax benefit
Spouse
Anyone

Means-testing / bankruptcy advantage
No
Yes

Tax-strategy diversification
Use
both

I don’t think the few years’ gap in account accessibility is an issue. You can always drawdown harder on pensions until age 60. 

Interestingly, the government seems to have cooled its jets on advancing the normal minimum retirement age in lockstep with the State Pension age. 

Accessibility aside, the LISA’s low allowance, restrictions on contributions beyond age 50, plus the principle of tax-strategy diversification all suggest maxing out the LISA if you can. 

That goes double if your financial position means that salary sacrifice actually makes you worse off. Hit that link for the gory details. 

Pensioned off

There have probably been retirements that lasted less time than it took to write this post. Alas recent developments have not made the SIPP vs ISA question any easier to answer, I’m sorry to say. 

But I hope this guide helps you think through the options. Assuming you haven’t lost the will to live in the meantime. 

Do I need to plug taking employer pension contributions one more time? Probably not!

Take it steady,

The Accumulator

P.S. Here’s more on how much should you should put in a pension and how much you need to retire. 

The Normal Minimum Pension Age will be 57 for most people from 5 April 2028.As the rules stand.That includes the Personal Allowance and any 25% tax-free cash.7.5% this year as per the OBR’s inflation forecast and 3% per year up to 2028.Personal Allowance

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We tackle the thorny old problem of SIPPs vs ISAs, and as usual there’s no clear winner…
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