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Published 12 April 2024
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Pension or ISA: Which is the Better Investment?

Pensions and ISAs are both tax-efficient ways to save. Knowing how they compare is key to using each most effectively.

Pensions and ISAs are both tax-efficient savings vehicles, with generous savings allowances, which make them ideal for big, long-term, financial goals.

However, there are significant differences between the two products, most notably in terms of access and tax. Here we explain how pensions and ISAs work to explore the role both can play in helping you achieve your long-term financial goals.

Pension or ISA?

In an ideal world, you’d be able to save into both a pension and an ISA. Which is better for you, though, will depend on a few factors.

If there’s any chance that you’ll need access to your money before the age of 55, an ISA will almost certainly be the better option of the two. However, if you already have adequate savings that are easily accessible set aside, the fact you can’t generally access a pension until later in life may help if you’re someone easily tempted to spend money that you have.

Saving into a pension is vital if you can afford it, and the tax benefits attached to pension saving are superior to those offered by an ISA as well.

Pensions and ISAs compared

AccessYou cannot access a pension until you are 55 (rising to 57 in 2028)You can access money in an ISA whenever you like (unless it is a fixed rate cash ISA)
TaxTax relief on pension contributions. Money grows tax free. When you access your pot, 25% can be taken as a tax free lump sum the rest is potentially taxable Money grows tax free. No tax will be payable when you take money out of your ISA
Allowance100% of your income up to £60,000 each year£20,000 each year
Investment choiceContributions can be invested in cash, bonds, shares and funds, with choice varying according to providerContributions can be invested in cash, bonds, shares and funds, with choice varying according to provider

Is a pension or ISA best for me?

You can often get access to the same – or very similar – investments whether you are investing in a pension or an ISA. The product which works best for you will ultimately depend on your savings goal.

For retirement savings, a pension is usually best. In addition to the tax relief on contributions – which can have a massive impact on the eventual value of your pot over the decades – the fact that your money is tied up until you are 55 (57 from 2028) means you won’t be tempted to spend it on anything else. Although your pension income will be taxable, when you retire you may pay a lower rate of tax than you did in your working life.

ISAs by contrast may be better for other major savings goals. Investment allowances are generous, allowing you to build a big tax-free pot of cash and unlike a pension, you can access the money whenever you need it.

However, as most people will have a range of savings goals – including retirement – it usually makes sense to have both a pension and an ISA. You may also find it makes sense to put some later life savings into an ISA to keep your retirement income as tax efficient and flexible as possible. Taking some money from an ISA in retirement, for example, may mean you need to take less out of your pension and reduce the amount of income tax you pay on your overall income.

An experienced independent financial adviser (IFA) will be able to help you pick the right products for your savings goals and plan your retirement income as tax efficiently as possible.

» MORE: Everything you need to know about pension advice

What is a pension?

Pensions are designed purely for retirement saving and have special features that encourage us to save. In addition to tax-free growth, savers also get tax relief on pension contributions. In simple terms, this provides savers with a rebate, equivalent to their rate of tax, to top up their pension. That means it only costs a basic rate taxpayer £80 to invest £100, a higher rate taxpayer £60 and an additional rate taxpayer just £55.

If it’s a workplace scheme, you get the benefit of employer contributions too.

However, in return for these incentives you won’t be able to access your money until you approach retirement. At the moment, you can start accessing your pension as soon as you turn 55, but from 2028 that age will rise to 57.

A key attraction of pensions is that you can take 25% as a tax free lump sum. Thereafter, money from your pension could be subject to tax, depending on your overall income.

Each year you can invest 100% of your income into a pension, subject to an overall cap of £60,000. This is known as your annual allowance.

Most people use their workplace pension. However, if you don’t have access to one, you can open a private personal pension

What is an ISA?

ISAs are considered all-purpose savings vehicles. You can use them to save for retirement should you wish, or any other financial goal you might have.

ISAs also come with generous tax benefits to encourage us to save. Like pensions, savings in an ISA will grow tax free, but you won’t get tax relief on contributions. Instead, when you take your savings out of your ISA, that money won’t be subject to income or capital gains tax.

You don’t have to tie your money up with an ISA either, and can dip into it whenever you need to.

Each year you can invest £20,000 into an ISA, this is known as the ISA allowance.

Confusingly there are several types of ISA. These are:

You can spread your £20,000 allowance across the different types of ISAs each year if you’d like. It is also worth noting that you can only open one of each type of ISA in the same tax year.

When people talk about using ISAs instead of pensions or other long-term savings optionsgoals, they are usually referring to stocks and shares ISAs. This is because both will allow them to access stock market-based investments that are considered suitable for long-term saving. In fact, if you ran your accounts on an online investment platform, you could hold identical investments in a SIPP and a stocks and shares ISA.

Cash ISA interest rates have risen in recent months and can be a valuable option for many. The positives of cash ISAs are that they come at no investment risk and do not come with complex charges, making them perfect for short-term savings or for those who want no investment risk. If you are willing to take this risk you might consider longer-term investments, such as stocks and shares ISAs or pensions. Innovative finance ISAs – which let you invest your ISA allowance in peer-to-peer loans – are still considered a left-field option and remain untested over the long term.

Lifetime ISAs, which are structured to help people save for either a home purchase or later life could be considered but they are subject to different rules and have different allowances to other ISAs.

WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.

Image source: Getty Images

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