Pensions and ISAs work differently, each with their own unique set of rules. But both are tax-efficient ways to save for retirement.
So, how do you know if one or the other will be right for you and your plans for when you stop working?
We’ve taken a closer look to help you figure out what suits you best.
ISAs and pensions compared
- No tax relief is given on payments into an ISA
- The accumulated savings fund grows tax-free
- No Capital Gains Tax or Income Tax is payable when savings are accessed
- An ISA forms part of your estate, unless left to an exempt beneficiary such as a spouse or civil partner. If your estate is more than the inheritance tax nil rate band of £325,000, tax at a rate of 40% could be payable on any excess
- No additional tax is payable (unless inheritance tax applies)
- The earliest you can access your savings is aged 16 for cash ISAs and 18 for stocks and shares ISAs (also called investment ISAs)
- The earliest age you can make payments is aged 16 for cash ISAs and 18 for stocks and shares ISAs (also called investment ISAs). There is no maximum age limit. Children under the age of 18 can have a junior ISA opened on their behalf from birth
- Investment is allowed in cash, shares, government and corporate bonds. In addition to direct investments, a wide range of funds are available which invest in cash, shares and bonds and other investments such as property. Direct investment in residential property isn’t allowed
- The maximum annual allowance is £20,000 for the 2021/22 tax year. Unused annual allowance cannot be carried forward. There is no lifetime allowance or maximum overall saving amount
- Employers can’t make payments on your behalf
- Tax relief on personal payments into your pension for amounts up to £40,000 or 100% of your annual earnings (whichever is less)
- Usually the most that can be added to your pension in a year before you start paying tax on it is £40,000. This limit is reduced in certain circumstances
- The accumulated savings fund grows tax free
- No Capital Gains Tax is payable when savings are accessed
- Usually 25% of your pension can be taken tax-free. Income Tax is charged on the remaining amount when it’s taken from the pension
- Your pension fund is not normally counted when working out the taxable value of your estate for inheritance tax
- There’s a lifetime allowance limit on the amount that you save in pensions. For most people, the limit is currently £1,073,100. Only people above this limit have to pay an extra tax charge on their pension savings
- The earliest you can usually access a pension is age 55, although earlier access is possible in the case of ill health
- Payments to your pension can be made from birth to age 75
- Investment is allowed in cash, shares, government and corporate bonds. In addition to direct investments, a wide range of funds are available that invest in cash, shares and bonds and other investments such as property. Direct investment in residential property isn’t allowed
- If you are employed and earn enough, your employer must enrol you into a pension scheme. In most cases they’ll also pay into your pension scheme for you
As you can see from this comparison, ISAs and pensions are actually quite similar. But what might tip the balance in favour of one or the other?
Why choose an ISA?
ISAs are the most flexible form of tax-efficient savings plan available.
Although ISAs can be accessed at any time, including under the age of 55, stocks and shares ISAs are usually taken out with the intention of keeping the investment in place for the medium to long-term (5 years plus).
Why choose a pension?
If you don’t need access to your money before you turn 55, the advantage of a pension is that you get tax relief on the payments you make into it. You don’t get tax relief when you make payments into an ISA.
Also, if you are employed and eligible, your employer must enrol you into a pension scheme and, in most cases, will pay into the scheme on your behalf. Employer payments boost your own contributions and could, in a sense, be regarded as free money.
Opting-out of a pension scheme
Anyone thinking of opting-out of a pension to save into an ISA should consider the fact that they would lose the benefit of tax relief, as well as any employer’s pension contribution.
So, how do I choose?
- Consider a pension for your savings or investments if you don't need to use the money before age 55
- ISAs are the most flexible tax-efficient home for your savings and investments, as you can access them at any time – although stocks and shares ISAs are usually held for the medium to long-term
- The combination of solutions you use will depend on how much money you have available to save or invest. What is clear is that using all these allowances together allows very large amounts of savings and investments to be sheltered tax efficiently
With both stocks and shares ISAs and pensions, the value of investments can go down as well as up and you may get back less than has been paid in. The value of a cash ISA may not keep pace with inflation.
This article is not intended to give advice or a personal recommendation. If you need a personalised recommendation based on your personal circumstances, you should seek financial advice. You can find a financial adviser in your area at www.unbiased.co.uk.