Pensions and ISA’s work differently, each with their own set of rules. But both are tax-efficient ways to save for retirement. So, how do you know which account to put your spare money into? We have explained ISA’s and Pensions to help you figure out what suits you.
Please remember that this is information based on standard practice. Your situation may be different, and we suggest you seek personal professional advice before making financial decisions.
ISA vs Pension
ISA
- 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.
- No extra tax is payable unless inheritance tax applies.
- The earliest you can access your savings and make a payment is aged 16 for cash ISA’s and 18 for stocks and shares. ISA’s also called investment ISA’s.
- Employers can’t make payments on your behalf.
- 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.
Pension
- 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.
- 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.
- 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, ISA’s and pensions are pretty similar. But what might tip the balance in favour of one or the other?
Why choose an ISA?
An ISA is a product that allows you to save money without paying tax on the interest you receive. In the 2021/22 tax year, the maximum amount you can keep in an ISA is £20,000. You can usually withdraw the money as and when you need it.
ISA’s are the most flexible form of tax-efficient savings plan available.
Although ISA’s can be accessed at any time, including those under the age of 55, stocks and shares ISA’s are usually taken out with the intention of keeping the investment in place for the medium to long-term.
Why choose a pension?
A pension is a product for saving specifically for retirement, so you won’t be able to access it until you’re a certain age, currently 55, apart from in very rare situations. One of the key benefits of saving into a pension is that the government contributes too in generous tax relief.
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 contributions and could, in a sense, be regarded as free money.
How do I choose?
- Consider a pension for your savings or investments if you don’t need to use the money before age 55.
- ISA’s are the most flexible tax-efficient home for your savings and investments, as you can access them at any time, although stocks and shares ISA’s are usually held for the medium to long term.
