Image source: Britfetch (copyright Evan Doherty)

What’s the difference between investing £10,000 in a FTSE 100 index tracker and putting the same amount into a Self Invested Personal Pension (SIPP), and then using that to invest the full amount in the same index tracker?

The answer may surprise you!

A SIPP structure can offer investors a compelling benefit

When we invest, we often expect that the amount of hard-earned cash we have put into an investment platform may be reduced by things like fees, commissions and dealing costs.

Unfortunately, this is also true when investing through a SIPP.

However, a SIPP can offer a big immediate advantage over other investment structures: tax relief.

I’m not talking about tax-free capital gains and income inside the wrapper, just like a stocks and shares ISA offers. This also applies to a SIPP, although the rules for withdrawal (both in relation to tax and when this can be done) are different to an ISA.

Please note that tax treatment depends on each client’s individual circumstances and may be subject to change in the future. The content in this article is provided for information purposes only. It is not intended to be, and does not constitute, any form of tax advice. Readers are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.

Doing more with the same amount of money

No, I’m talking about the tax break.

In short, the government will increase the amount you put into your SIPP as a means of effectively reclaiming the income tax you paid on the money in question (interest-free).

For higher and additional income taxpayers, this can be a huge benefit.

Even for standard-rate income tax payers, this may be too strong. In fact – and surprisingly – even non-taxpayers can get this tax break.

In practical terms, this means that someone who invests £10,000 in a SIPP will actually have £12,500 to invest without investing any additional money of their own.

More money, more returns

Let’s put that in perspective.

Over the past five years, the FTSE 100 has risen by 45%. So someone who invested £10,000 in a tracker in a share trading account five years ago would now have around £14,500.

But someone who put the same amount (£10,000) into a SIPP and then bought the same tracking device would now be sitting on a SIPP worth around £10,000.18,125.

And that’s even before we take into account the dividends along the way.

The amount of passive income earned will be 25% higher thanks to the tax-free effect of the SIPP, compared to making the same moves outside the SIPP wrapper.

In search of SIPP winners

In fact, I currently don’t have any index trackers in my SIPP.

But I was investing directly in some FTSE 100 shares.

One that performed poorly is JD Sports (London Stock Exchange: JD). While the FTSE 100 has risen by 45% over five years, the same period has seen the JD Sports share price fall by three-fifths.

Also, the profits are not exciting. The 1.7% yield is well below the 3.1% offered by the broader index.

So, why am I stuck?

I don’t ignore the risks. Weak consumer spending threatens demand for expensive sportswear. The value of JD Sports’ expansion program over the past few years remains to be proven. But it boosted the British company’s global footprint and economies of scale.

The brand is strong and the company remains very profitable. Earnings before tax and adjusted items fell last year, but remained at £852m.

The share looks undervalued to me. I plan to keep it in my SIPP!