Pension, ISA or property for the self-employed: which is better?

Important information - the value of investments and the income from them can go down as well as up, so you may get back less than you invest.

Many self-employed workers could be risking their retirements by ploughing their wealth into property and their business while overlooking pensions. Research from the Institute for Fiscal Studies (IFS) shows that the self-employed typically hold much more of their wealth in those two areas than employees, but far less in pensions.¹

For entrepreneurs and freelancers, choosing the right investment vehicle for retirement is a very important decision.

Leaving business investment to one side for now, the choice often comes down to: investing into an ISA, a self-invested personal pension (SIPP), or buy-to-let property. Here we look at the benefits and drawbacks of each one.

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SIPP vs ISA vs property

Tax benefits

Buy-to-let property has historically been a popular investment among entrepreneurs, but its tax advantages have eroded over time. Mortgage interest relief has been phased out, and stamp duty surcharges have increased and the government has increased tax rates on property income. Capital gains tax when the property is sold, and maintenance costs further reduce net returns. 

By contrast, both ISAs and SIPPs offer generous tax benefits.

You can save up to £20,000 per year into an ISA and any interest or returns you make will be tax-free. You can also withdraw the money without incurring any tax. For long-term goals, like saving for retirement, a stocks and shares ISA is a generally considered a much better option than a cash ISA.

SIPPs, meanwhile, offer generous tax relief on contributions. For basic-rate taxpayers, a £100 pension contribution will only cost them £80 thanks to the tax relief top-up by HM Revenue & Customs. Higher-rate and additional-rate taxpayers can claim additional relief via their tax return, meaning a £100 pension contribution would only cost them £60 and £55 respectively.

Like with an ISA, any returns from your SIPP investments are tax-free. Finally, while withdrawals from a SIPP are taxed, 25% can be taken tax-free (up to a maximum of £268,275). This magical trifecta of tax relief on contributions, tax-free growth and up to 25% tax-free on withdrawal is the key reason why SIPPs are generally considered the best vehicle when saving for retirement.

Diversification

Diversification is just another way of saying: “don’t put all your eggs in one basket”.

With buy-to-let property, your returns are entirely dependent on the performance of one property. If house prices in that area fall, or the property has problems like subsidence, your wealth will be severely impacted.

The same applies to investing in your business. Like with property, your financial future is tied to one asset. If the business fails, underperforms, or becomes unsellable, your retirement plans could collapse. Even if your business is valuable, it may not be easy to convert into cash when you retire. For many entrepreneurs, they are their business so if they fall ill and are unable to work, the value of the business can evaporate quickly. 

Whereas, both ISAs and SIPPs allow you to create a diversified portfolio of investments, covering different geographies and sectors around the world. If one area of stock markets performs poorly, diversification could help to protect your portfolio from falling too far.

For ideas and tips on how to build a diversified investment portfolio if you’re self-employed, read our article: Best investments for a self-employed pension - whatever your age.

Ease of access to cash

The key thing with retirement savings is you need to be able to access them easily once you stop working.

Property is not always easy to sell, and you can be forced to accept big discounts if trying to offload at speed. Some buy-to-let owners will rely on the income from their property in retirement, which means selling isn’t a problem. However, rental income can be patchy if the property has void periods.

Mainstream investments in both ISAs and SIPPs are usually very liquid, meaning they can be sold in a few days.

You can access funds in an ISA at any time. With a SIPP, you can currently access your funds from age 55 - rising to 57 from April 2028.

Returns

Long-term growth in house prices has convinced many people that property is the “golden bullet” asset class, guaranteed to make you money.

However, our own Fidelity research shows that isn’t necessarily true. Over the past three years, the value of UK residential property has fallen by 9% when inflation has been accounted for. Over five years the real (i.e. after-inflation) return has been -2%.

Only when you look at a 10-year period does property deliver inflation-beating returns, with a real return of 6%. 

Compare this with global stock markets which have delivered a real return, after inflation, of 26% over three years, 45% over five years and 132% over 10 years.

These numbers do not consider rental income, which has enjoyed strong growth in recent years.

Why SIPPs win for retirement

The choice of whether to put your retirement savings into a SIPP, ISA or property will depend on your personal circumstances. But, for most people, a SIPP is likely to be the best option.

Putting your retirement savings into a SIPP means you benefit from:

• Tax relief of up to 45% depending on your tax bracket, which boosts contributions significantly
• The potential for long-term growth from global equities - with no tax on that growth
• Up to 25% of withdrawals tax-free
• Carry-forward rules, which allow unused allowances from previous years to be utilised so long as you were a member of a registered pension scheme
• A wide range of investment choice, including funds, shares, and even commercial property from around the world
• Flexible access to your money after you reach retirement age
• Open a Fidelity Self-invested Personal Pension (SIPP)

Once you’ve settled on a SIPP, you then need to decide what investments to buy and how much to invest. Luckily, we have both topics covered in our series below.

• Read: I’m self-employed - how much should I save for retirement?
• Read: Best investments for a self-employed pension - whatever your age

Source:

¹ Private pensions for the self-employed: challenges and options for reform, IFS, September 2024