Both pensions and individual savings accounts (ISAs) have several tax advantages, which can make it tricky to work out which is better to use when you’re saving for retirement.
Here we look at some of the differences between the two to help you decide which might be the best home for your money – or whether a combination of both might be the best option. Bear in mind that tax rules can and do alter, and the Autumn Budget brought in new changes, which are set to bring pensions into the scope of Inheritance Tax for the first time from 2027.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
Pensions and ISAs compared
What are the tax benefits of pensions?
Under current rules, investments made into your pension are not subject to either Capital Gains Tax (CGT) or income tax.
But one of the biggest advantages of saving into a pension is that you get tax relief on the money you pay in. This means that if you’re a basic rate taxpayer, for every £80 you contribute, you’re actually putting away £100 as the taxman automatically refunds you the £20 in income tax it would have taken. You can find out more in our article How pension tax relief works.
Higher-rate taxpayers can claim a further £20 back through HMRC via their self-assessment tax returns, resulting in a net cost of only £60 for a pension contribution of £100, whilst additional rate taxpayers can claim a further £25 back. Learn more in our article How do I reclaim higher rate pension tax relief?
For most people, tax relief on a pension is restricted each year to contributions of up to 100% of their income or £60,000, whichever is less. Any pension payments you make over the £60,000 threshold will be subject to usual income tax rates. You can find out more about current pension allowances in our guide Understanding your pension allowances.
Another benefit of pensions is that if you belong to a company scheme, your employer will also usually contribute to your pension pot. This means you’re effectively being given free money by your employer which you’ll be able to use in retirement. Some companies have matching contribution schemes where the more you pay in, the more your company will pay in – up to a limit. If you are unsure exactly how your current employers’ scheme works, it may be worth speaking to your line manager, or an HR representative to ensure you’re making the most of any possible employer contributions.
If you haven’t been automatically enrolled into your company pension scheme, perhaps because you work part-time or are on a low income, you can ask to join and your employer cannot refuse. Find out more in our articles How does pension auto-enrolment work? and Can I join my workplace pension scheme if I’m on a low salary?
It’s also worth noting that depending on your age at death, you may be able to pass your pension to your loved ones tax-free, and it won’t form part of your estate for Inheritance Tax purposes either. Find out more in our guides What happens to my pension when I die? and Can my pension be used to reduce Inheritance Tax?
However, this is set to change from April 2027, after the Chancellor Rachel Reeves announced in the Budget that from this date, pensions would become liable to IHT. Find out more in our guide Budget 2024 pension changes.
What are the tax benefits of ISAs?
When you save into an ISA, although you don’t get tax relief from the Government, as with a pension you won’t be charged tax on the savings interest or any capital gains you make on your investments.
The maximum you can pay into an ISA in the current tax year (2024/25) is £20,000. You get a new ISA allowance at the beginning of each new tax year starting on April 6, so if you can afford to put money away every year, you can create quite a significant tax-free savings pot over time. Any part of your allowance you haven’t used by the end of the tax year cannot get carried over into the next tax year.
Some ISAs allow you to withdraw cash and then replace it within the same tax year, without this affecting your annual tax-free allowance. For example, if you pay in £20,000 and withdraw £1,000, you may be able to replace the £1,000 as long as you do so in the same tax year as you made the withdrawal. ISAs that allow you to do this are called flexible ISAs but not all offer this flexibility.
Unlike pensions, ISAs do fall into your estate for Inheritance Tax purposes. Find out more in our guide Can you inherit an ISA?
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Where your money goes
Pensions
Your pension provider will usually invest your money in your pot into a range of investment funds. There is a risk that these will rise or fall, and this is why as you approach the time when you’re due to retire you may want to consider moving your money into lower risk funds to avoid the risk of a significant fall in the value of your assets just before you retire.
With most pensions, unless you’re taking a DIY approach and managing your investments yourself, your money usually goes into a ‘default fund’ which transfers your money into lower risk investments automatically as you near retirement. This fund might not always be the best option for you however, so you’ll need to be proactive and check where your money is invested. Find out more in our article Where is my pension invested?
ISAs
When you pay into an ISA, you can either pay your full £20,000 allowance into investments, cash, or peer-to-peer lending, or you can split your allowance between a combination of these options. Our article Best cash ISA rates: Which cash ISAs pay the most interest? explains which cash ISAs pay the best returns if you don’t want to take any risks with your money. Bear in mind, however, that cash ISA returns can still be impacted by high inflation, which erodes the purchasing power of your cash. Learn more about this in our guide What does 1.7% inflation mean for my money?
If you choose an investment ISA, lots of investment services now provide a selection of ready-made investment portfolios, some of which are aimed at novice investors, whilst others target more sophisticated investors, who might be comfortable accepting a higher level of risk in the hope of potentially higher returns. You’re directed to a portfolio that should be suitable for you after answering a series of questions. These questions typically focus on your approach to risk (how much can you afford to lose), your financial objectives, and your investment timeframe (how soon you might need to access your money). Learn more about how each of these different options work in our guide Everything you need to know about ISAs.
Accessing your money
Pensions
Any money held in a pension is locked away and you can only access it when you reach a certain age. This is currently set at 55 if you have a defined contribution or money purchase pension (rising to 57 by 2028), but you’ll need to check with your provider when they will allow you to withdraw your savings. Bear in mind that the minimum age at which you can access a private pension is set at 10 years below the State Pension age, and the State Pension age is gradually increasing.
When you take money out of a pension 25% of withdrawals are tax free, whilst the remaining 75% is subject to income tax. The amount you can take tax free from your pension pot is limited to £268,275. Find out more in our guides Your pension options at retirement and How much tax-free cash can I take from my pension?
ISAs
With an ISA you are free to access your savings whenever you want to, penalty-free – subject to any specific product restrictions such as a fixed-rate Cash ISA that needs to be held until the term is complete.
If you’ve chosen an investment ISA, it’s important to remember that investing is for the long-term, so you should ideally leave your money for at least five to 10 years to give it the best possible chance of riding out any stock market volatility.
All withdrawals from an ISA are tax-free.
Entitlement to benefits
Pensions
If your circumstances change – say you lost your job, and you need to claim benefits – then your pension pot is not usually taken into account when you’re assessed.
ISAs
Any money you have in an ISA is seen as an asset that you can access right away and could therefore affect your eligibility to receive certain means-tested benefits. Learn more about this in our article How lump sum payments and savings can affect your benefits
Savings made easy with Raisin UK
Raisin UK provides a free savings platform where you can apply to open savings accounts with over 30 banks and building societies. Enjoy competitive interest rates from FSCS-protected banks.
Can I have both an ISA and a pension?
There’s nothing stopping you having an ISA and a pension, so if you want the flexibility of being able to access your cash before you turn 55, but you also want to benefit from tax relief and free employer pension contributions, you could choose to save into both. This gives you more options to play with and when you do retire you can then decide how you want to use the money as a retirement income.
As returns from investments within both ISAs and pensions are protected from income tax, dividend tax and capital gains tax (CGT), they can both be useful when planning for retirement, especially as dividend and CGT allowances have both reduced substantially this tax year.
If you want personal recommendations about where to invest your retirement savings, you’ll need to seek professional financial advice. You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guides on How to find the right financial advisor for you or How to get advice on your pension.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
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