Pension or ISA?

Which should you invest in to help save for retirement?


What are ISAs and pensions?

Both ISAs and pensions offer a tax-efficient way of saving for the future. But which is the better option for seeing you through retirement? On this page, we’ll take a look at how ISAs and pensions work, along with the pros and the cons offered by each.

What is an ISA?

An ISA is an Individual Savings Account, which allows you to save up to £20,000 per tax year without having to pay tax on any returns. There are two main types:

  • Cash ISA – Similar to a regular savings account, you receive interest on the money you save
  • Stocks and shares ISA – An ISA where your money is invested and returns are paid courtesy of any gains the investments make. The value of the investments can go down as well as up and you can get back less than you’ve invested.

Both types of ISA are available as Lifetime ISAs, which are covered further down the page.

What is a pension?

A pension is a savings scheme used to put money away for retirement. It offers tax relief at a basic rate of 20%, which can be claimed off the government by your pension provider. In the case of a workplace pension, your contributions may be paid prior to tax, which has the same outcome for your pension pot.

A pension is long term and inaccessible until the holder is at least 55 (rising to 57 in 2028). Unlike a regular savings account, which offers interest, a pension is invested and can therefore lose, as well as gain money.

There are three main types of pension in the UK. The state pension, workplace pensions and what we’ll be discussing on this page, personal (also known as private) pensions.

Personal pensions vs ISAs – comparisons at a glance 

Personal pension scheme
What level of access is there?
The money in a pension is inaccessible until you reach the age of 55 at the earliest.
In most cases, you can access the money in an ISA whenever you want it (give or take a few days with a stocks and  shares ISA).
What is the tax status?
Any gains are tax-free
Any gains are tax-free
How much can you contribute annually?
You can contribute as much as you like, but only the first £60,000 or 100% of your earnings, whichever is lowest, would qualify for tax relief.
£20,000. This can be increased by however much was in a legal spouse or civil partner’s ISA, if they have passed away.
Does it qualify for tax relief?
The government pays 20% tax relief on your contributions. This will be claimed back by your pension provider on your behalf.
What happens when you die?
Your pension will be paid to whoever you nominate with your provider.
Your ISA can be left to a chosen beneficiary in a will or passed on according to rules of intestacy.
Is it classed as part of your estate for Inheritance Tax (IHT) purposes?
Unless passed on to a legal spouse or civil partner, an ISA is included in your estate and subject to IHT.

The Financial Conduct Authority does not regulate Inheritance Tax Planning and Trusts.

A word about workplace pensions

Before continuing, it’s worth mentioning that if you’re in a workplace pension scheme it’ll almost always be worth making regular contributions and building up a pot of money that’ll make up your main source of funds in retirement.

This is because your employer must also contribute a minimum amount to your pot, with the same regularity as you do. If it’s an automatic enrolment pension scheme, you will pay a minimum of 5% of your earnings, while your employer will pay a minimum of 3%.

Workplace pensions include the Teachers’ Pension Scheme, the Scottish Teachers’ Pension Scheme, the Scottish Teachers’ Superannuation Scheme, and the NHS Pension Scheme. These have their own minimum employee and employer contribution rates, which you can find in our Teachers’ and NHS Pension Scheme guides.

Stocks and shares ISA or pension?

If you’re not in a workplace scheme, or you’re looking to supplement your work pension with further retirement savings, you might consider an ISA or a personal pension.

When comparing pensions and ISAs, we are referring specifically to personal pensions and stocks and shares ISAs (both standard and lifetime). This is for two reasons:

  • Both products are invested and therefore you might get back less than you put in (a cash ISA has a guaranteed return via its interest rate)
  • A personal pension doesn’t benefit from the additional contributions an employer has to pay into a workplace pension.

This makes for a fairer comparison.

What are the tax implications?

Both a standard stocks and shares ISA and a personal pension scheme have tax advantages, as detailed below:

  • The ISA benefits from a tax-free status. You can contribute up to £20,000 per tax year without having to pay tax on any gains it makes.
  • If your scheme is registered for HMRC tax relief, a personal pension is also tax-free as far as potential gains go. The annual limit is £60,000 or 100% of your earnings, whichever is lower. Anything above this amount becomes liable for a tax charge.
  • Any withdrawals from an ISA aren’t liable for tax.
  • If you take the money from your pension pot as a lump sum, the first 25% is tax-free, anything after that is taxable. If you choose a guaranteed income via a pension annuity, normal income tax is payable, as it would be with your salary.

A personal pension also gets tax relief. This means the government will pay in an additional 20% of your contributions, effectively paying back the income tax you have already paid on your money at the basic rate. If you are a higher-rate taxpayer, it's also possible to claim an extra 20% tax relief, totalling 40% in line with the higher tax band.

Tax treatment depends on individual circumstances and may be subject to change in future.

Can you easily withdraw your money?

One of the key deciding factors in choosing between a stocks and shares ISA or a pension is the ease with which you can access your money.

Accessing a stocks and shares ISA

A standard stocks and shares ISA, although intended as a long-term investment, would give you greater freedom than a pension when it comes to taking money out. The amount you needed would be available on request as soon as the corresponding investments were sold.

Of course, this freedom can be counterproductive to your goal of saving enough to enjoy your retirement. Every ISA withdrawal you make will ultimately eat into the amount you eventually have to retire on. This applies not only to the pot your contributions make, but also the potential for returns.

Accessing a pension

In contrast to an ISA, a pension won't give you the same level of freedom. Once you start a pension, your money is locked away and the earliest you can access it is at 55. This age is due to increase to 57 in 2028.

The advantage of the pension age limit is there’s no temptation to dip into your pot early, reducing it and diminishing the potential returns. This gives it time to grow and, if you’ve paid in enough and the investments have been kind, put you on track to the retirement you’ve planned.

Lifetime ISA or pension?

A Lifetime ISA (LISA) is a type of ISA that, although offering the standard £20,000 per year tax-free status, has its own specific set of rules.

Available to savers between the ages of 18 and 39, the LISA can be used for one of two things. Either to save for retirement or buying a first home. The home-buying aspect has its own rules, discussed elsewhere, but regardless of what you plan to do with it, a LISA allows you to contribute up to £4,000 per tax year.

However much you pay into a LISA during the year, the government will top up your contribution with an additional 25%. So, if you managed to put away £2,000, you would receive an additional £500. If you saved the maximum of £4,000 in a year, you’d get £1,000. This top-up continues until you reach your 50th birthday.

It’s not all plain sailing though. Unlike a regular ISA, you don’t have the freedom to access your money as and when you like. If you make a withdrawal from a Lifetime ISA and it’s before you reach the specified retirement age of 60, or isn’t for a first home, you will be charged a 25% withdrawal fee.

This charge is 25% of the ISA’s value, including any bonus, so you could end up with less than you put in.

Benefits of pension scheme over Lifetime ISA

With the 25% government bonus on top of whatever you contribute, a LISA can seem a tempting alternative to a pension. It is worth noting, however, that there are a few factors where the pension comes out on top.

  • With a pension scheme, you’re not tied to a £4,000 annual limit. You can pay in up to £60,000 with a pension, allowing you to build a more substantial pot, with the potential for greater returns.
  • With the Lifetime ISA, the £4,000 annual limit comes out of your personal ISA allowance. So, if you were to contribute the maximum £4,000, you would then only have £16,000 of your allowance left to split between other types of ISA.
  • With a pension, you can currently begin accessing your money at the age of 55. If you’re using your Lifetime ISA to save for retirement, you can’t touch it until you’re 60. This may not be such a disadvantage, as it gives your investment more time to grow, but if you were hoping to use it towards an earlier retirement, there’s an extra five years to wait beyond a pension.
  • If you’ve left it late to start saving for your retirement, you may not be eligible for a Lifetime ISA. Whereas you can open a pension and get the tax benefits up until the age of 75, the LISA is no longer available to you once you reach the age of 40.

If you are aged between 18 and 39, and have the resources, saving into a Lifetime ISA for retirement could make a nice addition to your pension. On its own, however, you would have to question whether it suited your retirement needs over that of a proper pension scheme.

Cash ISA or pension?

A cash ISA allows you to save up to £20,000 per tax year, tax-free. This means that unlike a standard savings account, you don’t pay tax on any of the returns. Like a savings account, however, the returns are based on the interest rate of the cash ISA product you have.

As pensions are investments, with any gains or losses tied directly to the performance of the markets, it is unfair to compare the two.

Pension or ISA – Which is best for you?

It isn’t a black and white case of one or the other. As we have shown, pensions and ISAs both have their advantages and, depending on your needs, some disadvantages.

If you have the financial means to do so, pensions and ISAs can be used together as a balanced and tax-efficient way to aim towards maximising your retirement fund.

Bear in mind the value of investments can go down as well as up. You could get back less than you invest.

The content of this page is provided for information purposes only.

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