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.
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. Income tax on rental profits,
capital gains tax when the property is sold, and maintenance costs further reduce net returns. There have also been rumours the Treasury could start charging National Insurance on rental income – which would make owning buy-to-let property even less tax efficient.
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, every £80 contributed is topped up to £100 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. 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.