401(k) vs SIPP: what are the key differences?

If you take even a passing interest in personal finance, you’ll probably have heard of a 401(k). Even in the UK, where the 401(k) doesn’t apply, people have likely heard of the US retirement savings tool. The closest 401(k) UK equivalent will be the UK’s workplace pensions and the SIPP, which help millions of people plan for retirement.

The SIPP is a tax-efficient and flexible way for people in the UK to prepare for a comfortable retirement. In this article, we’ll establish what both the 401(k) and the SIPP actually are and see if we can draw comparisons between the two despite their geographical differences.

What is a 401(k)?

The 401(k) meaning comes from a name in a section in the US Internal Revenue Service Code and it is a defined contribution retirement plan in the US. Offered by some employers through auto-enrolment, the 401(k) is a tax-efficient way for workers to save regularly for their retirement. The maximum limits for contributions are $19,500 per year for those under 50 and $26,000 for the 50+ workforce.

Much like a workplace pension in the UK, contributions are taken directly from the employee’s paycheque once they sign up for the scheme and are invested in funds of the employee’s choosing. The employer then may or may not choose to match the contribution. Unlike the workplace pension, however, the 401(k) is by no means mandatory. Not all employers offer retirement plans to their employees, which means many are made to turn to individual retirement accounts for their retirement plans.

Ultimately, the 401(k) pension is a solid way for US citizens to save for retirement. Many employers offer to match a portion of what you save, which means that you can maximise your retirement pot over time. If your employer contributes, the total limit for under 50 workers rises to $58,000 ($64,500 for those over 50).

There is also a Roth 401(k), which is different from the traditional 401(k). The main difference between the two is how they are taxed. 

Contributions to a traditional 401(k) are made using “pretax” dollars, which means dollars paid in salaries before any deductions have been made. With this type of 401(k) it means you don’t have to pay the IRA until you withdraw money. Contributions to a Roth 401(k) are made using “after-tax” dollars. Because you pay tax on the contributions, they are tax-free when you make withdrawals from a Roth 401(k). 

All 401(k) contributions made by the employer are made using pre-tax dollars regardless of whether they are paid into a traditional 401(k) or Roth 401(k).

Another US product that has been created to facilitate tax-efficient savings for retirement is the Roth IRA. Like the Roth 401(k), contributions are made from “after-tax” funds, so withdrawals are tax-free. But whereas you can contribute up to $30,000 per annum with the Roth 401(k), with a Roth IRA, you can only contribute up to a maximum of $7,500 per annum. 

The closest Roth IRA UK equivalents are stocks and shares ISAs and SIPPs. Although ISAs can be used to invest for retirement, they are not pensions. So, the answer to “What is a 401(k) UK equivalent pension-wise?” is a SIPP or workplace pension.

What is a SIPP?

A self-invested personal pension (SIPP) is similar to a traditional IRA or personal pension. However, it gives the holder greater flexibility when it comes to investment options. In terms of government tax reliefs, a SIPP is the 401(k) UK equivalent. The pension ‘wrapper’ makes it easy to invest for retirement and build up a pot over time without being subject to income or capital gains tax, for example.

Savers can choose to manage their investments themselves or with the help of a professional wealth manager. It’s this flexibility that makes SIPPs an attractive option – most traditional pensions offer very little flexibility regarding where the money is invested and how it’s managed.

Self-invested personal pension schemes also come with the added benefit of pension tax relief. In the UK, savers can pay up to £40,000 (or 100% of their earnings, whichever is higher) into their account every tax year. They also get relief of up to 45% on these contributions. Like the 401(k), contributions to the SIPP are topped up by the taxman, making them incredibly tax efficient. 

From age 55, SIPP holders can withdraw up to 25% of their pension completely tax-free, either as one lump sum or in instalments. You can also pass on your pension funds to your beneficiaries free of inheritance tax – it’s all free of charge. This means you can get an early retirement boost without paying a penny to the taxman.

Pensions in the UK have been growing steadily for the last decade or so. Workers are becoming increasingly aware that consolidation and active management of personal pension funds can make a massive difference over the long run. If you want to see what a fully managed, globally diversified SIPP could do for your long-term finances, take a look at Moneyfarm’s private pension, which is built and managed around each individual’s retirement goals.

What are the differences and similarities?

The fundamental difference between the 401(k) pension and the self-invested personal pension (SIPP) 401k UK equivalent is that the former is available in the US while the latter is for UK savers. However, they are both effective vehicles for long-term retirement planning and tax-efficient saving.

One key similarity is that your employer can pay directly into both. In both cases, employer contributions are paid in gross, meaning they’re not tax deducted first. If you’re in the UK using a SIPP, you’ll have to check with your provider, but with wealth managers like Moneyfarm, the process is straightforward for most people.

Another similarity between the 401k UK equivalent SIPP and the US 401(k) pension is that both can be most effective when topped up on a little-and-often basis. This is where it can be so helpful to pay into your account straight from your paycheque (particularly if your employer is willing to top up your contributions). This way, you can factor your savings into your monthly budget, which is more conducive to long-term responsible saving.

Equally, it pays to get started early with both a 401(k) pension and a self-invested personal pension (SIPP). Both US and UK retirement savers can benefit from the magic of compound interest if they start saving into their accounts early on in their careers. This is why many consider your early pension contributions to be your most important. Over the decades, the contributions have the chance to grow and, in turn, generate compounding interest.

How to get started with a SIPP

If you were interested in a 401(k) and now know that the answer to “what is a 401k UK equivalent” is a SIPP, you might be considering starting one and wondering when the best time to start is.

There’s no “right time” to consider opening a private pension. Ultimately, the sooner you can start your retirement plan, the better. Once you’ve saved enough for a rainy day and paid off any existing debts, it’s always sensible to turn your attention to your long-term finances.

It’s easy to open and fund a retirement savings account. With Moneyfarm, wealth managers quickly pair you with a portfolio that suits your long-term goals, retirement plans, and your financial situation, as well as your attitude to risk. We’ll then manage the account on your behalf so that you can get back to focusing on the here and now. Check out our private pension page for all the information you need about getting started with a SIPP of your own.

It’s easy to transfer any existing workplace pensions into your SIPP. Once you’ve opened your account with Moneyfarm, for example, you need to get in touch with a member of our investment consultancy team, and they’ll be happy to take care of any transfers on your behalf – you’ll only have to supply some paperwork. Consolidation can make retirement planning much more manageable; even something as simple as having real visibility and transparency about how much you have saved and where it’s all invested can take a lot of the stress out of the process.

FAQ

What is 401(k)?

The product 401(k) is a savings account designed as a pension to allow US citizens to save for their retirements. Like the UK workplace pension scheme, employers also contribute.

What is the equivalent of 401k in UK terms?

In UK terms, the equivalent of a 401k is the UK workplace pension or the SIPP (self-invested personal pension).

Is a pension the same as a 401K?

A pension is the same as a 401K as they are both pension plans. However, a pension is funded and managed by the employer. In contrast, a 401K can be funded by both the employer and employee but managed by the employee.

Can you lose money in a 401k?

Yes, you can definitely lose money in your 401(k). This is because funds in a 401K are invested entirely or partially in the stock market. Therefore, the value of a 401K depends on the stock market’s performance, and a bear market will depreciate the value of your 401(k).