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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 savings tool. It’s similar to the UK’s workplace pensions and the SIPP, helping millions of Americans 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) – which gets its name from a section in the US Internal Revenue Code – is a retirement savings plan in the US. Offered by some employers, the 401(k) is a tax-efficient way for a worker 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 paycheck 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 the plan, which means many are made to turn to individual retirement accounts to save. 

Ultimately, the 401(k) is a solid way for US citizens to save for retirement. The fact that many employers offer to match a portion of what you save 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). 

Contributions are taken before your wages are taxed, too, meaning that the income tax you’re paying can be significantly lower depending on how much you choose to contribute. Your money is also protected from the IRS once it’s in the plan – you won’t pay anything on the growth of your investments (until you withdraw, at least). 

What is a SIPP?

A self-invest personal pension (SIPP) is similar to a traditional personal pension, but it gives the holder a greater deal of flexibility when it comes to the choice of investments. The pension ‘wrapper’ makes it easy to invest for retirement and build up a pot over time, without them being subject to income or capital gains tax, for example. 

Savers can choose to either 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. 

SIPPs 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, getting 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. 

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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 tax man. 

Pensions in the UK have been growing steadily more flexible for the last decade or so. Workers are becoming increasingly aware that consolidation and active management of personal pension funds can make a huge 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 manage around each individual’s retirement goals. 

What are the differences and similarities?

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

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

Another similarity between a SIPP and the 401(k) 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 paycheck (particularly if your employer is willing to top up your contributions). This way, you can factor your saving 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) and a SIPP. Both US and UK 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 contributions to be your most important – over the decades, they’ll have a chance to grow and, in turn, generate compounding interest. 

How to get started with a SIPP

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

It’s easy to open and fund an account, too. With wealth managers like Moneyfarm, you’ll be quickly paired with a portfolio that suits your long-term goals 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. For all the information you need about getting started with a SIPP of your own, check out our private pension page

It’s easy to transfer any existing workplace pensions into your SIPP. Once you’ve opened your account with Moneyfarm, for example, you just 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 planning for retirement much easier; 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. 

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