What is the difference between a pension and an ISA?
Firstly, what is a pension? It’s just a pot of money you are saving for your later years, which is invested so it can grow and give you something to live on when you retire. A pension comes with certain juicy tax breaks, and you usually can’t withdraw money until the age of 55. You can join a pension scheme through your workplace, or set up your own such as a SIPP (which stands for a self-invested personal pension).
What is an ISA?
ISA stands for individual savings account, which is an account offered by banks, building societies or other providers into which you can save up to £20,000 a year tax-free. Most people don’t pay tax on their savings now anyway thanks to the government’s personal savings allowance, which protects interest of £1,000 a year for basic-rate taxpayers and £500 for higher-rate taxpayers from tax. But ISAs can still be useful if you are lucky enough to exceed this threshold, and can be good for other reasons too.
What are the different types of ISA you can buy?
| ISA type | Description |
| Cash ISA | An ISA for your cash savings. A key benefit is that up to £85,000 of your money is protected by the Financial Services Compensation Scheme in the event your ISA provider collapses. |
| Help to Buy ISA – now closed to new applicants. | Designed to help towards buying your first house by offering a 25% government bonus on savings, it has been replaced by the Lifetime ISA. |
| Lifetime ISA | A dual purpose ISA, designed to help you save towards retirement or home ownership. You can save up to £4,000 for the 2023/24 tax year, and the government tops it up by 25%. You can only access your money either at the age of 60, or to buy your first home, without incurring a penalty. |
| Stocks & Shares ISA | An investment account allowing you to invest up to £20,000 for the 2024/25 tax year. You can hold shares and funds without paying tax on your returns (whether capital growth or dividends). You can also hold cash in it. A Stocks & Shares ISA comes with all the usual risks and caveats of investing in the stock market, primarily that you could lose money. |
| Innovative Finance ISA | This ISA allows you to invest in peer-to-peer (P2P) lending through the ISA structure. Peer-to-peer lending platforms match individuals and businesses who want to borrow directly to those who want to lend. It’s a riskier prospect because borrowers may default on their loans, and P2P platforms can go bust or withdraw from the market – a few have in recent years – and they are not covered by the Financial Services Compensation Scheme.
Bear in mind also that it could take a while to withdraw your money if you need it and buyers can’t be found for your loans straight away. |
| Junior ISA | Anyone can save or invest tax-free in a Junior ISA on behalf of child, up to £9,000 for the 2024/25 tax year. Junior ISAs come in Cash and Stocks & Shares versions. Ownership of the money reverts to the named child once they turn 16, and they can withdraw it at age 18. |
What’s the difference between a SIPP and an ISA?
A self invested personal pension, or SIPP for short is a DIY pension, ideal for those who pretty much know what they are doing and feel confident to manage their own pension, choose investments that match their attitude to risk, and review them as required. A Stocks & Shares ISA is similar in that you can choose your own investments here too, but the main difference is the tax relief you get and the accessibility of your money. The returns from an ISA or a SIPP will depend on the success of your investment decisions.
Is it better to invest in an ISA or a pension?
Is an ISA better than a pension? It depends on what you are trying to achieve. In most cases you’ll be better off with a pension because:
- If it’s a workplace scheme, your employer pays in too, so you’re getting free money
- All pensions give you attractive tax breaks.
However, an ISA may be better depending on what you are saving or investing for. If it is a medium-term goal and/or you want access to your money sooner than retirement age, an ISA (or several) could be a good solution that is also tax efficient.
How much can I pay into a pension?
You can save as much as you want into a pension, but you will only get tax relief up to either 100% of your annual earnings or the annual allowance of £60,000 each tax year (this includes contributions from both you and your employer), whichever is lower. There is also a lifetime allowance in place, currently set at £1,073,100, but as of April 6, 2024, this will be abolished.
How much can I pay into an ISA?
You can pay in up to £20,000 each tax year, and you can split your allowance across the different types of ISA. For example, you could put £4,000 in a Lifetime ISA (this is the yearly maximum), £11,000 in a Stocks & Shares ISA and £5,000 in a Cash ISA, or any combination you like. You can also pay up to £9,000 per year into a Junior ISA on behalf of a child.
What are the tax benefits of a pension vs ISA?
When you save into a pension as a basic-rate taxpayer, you get an automatic 20% government top-up, while higher and additional-rate taxpayers can get an extra 20% or 25% (although they have to claim it back themselves). With ISAs, you don’t pay tax on any interest you earn. Any money you withdraw from an ISA will be tax-free, whereas money you take out of a SIPP will attract tax, except for 25% of your total pot that you are allowed to withdraw without incurring tax. For this reason, you might prefer to hold income-producing assets such as bonds within an ISA, so you can take out an income from it tax-free.
What investment choices do I have with a pension vs ISA?
It really depends what is available on the investment platform you are using. If your pension is a workplace pension, you will be restricted to whatever options that scheme gives you. If the options are limited, poorly performing, or don’t suit your preferences, there’s nothing to stop you opening your own pension such as a SIPP alongside it, but of course you won’t benefit from employer contributions into this pension pot so it probably shouldn’t replace a workplace pension.
When can I access the money in a pension vs ISA?
Any kind of investment ISA should usually be considered with a long-term investment view in mind, of at least three to five years. Your money is not locked away but it’s not so easily accessible as if you had put it in a cash savings account because you will need to sell investments to get your money back. If you are in a hurry to access your cash, you may end up selling at a less than optimal price. This is why you shouldn’t try to use an investment ISA as a cash machine, but stay invested for as long as you can. A pension is even longer-term than an ISA because it’s designed for retirement, so you usually won’t be able to access your money before the age of 55. This could be a benefit if you would otherwise be tempted to spend your long-term savings.
Who can inherit from my pension or ISA?
Most pension schemes will allow you to name anyone as a beneficiary who will inherit your pension when you die, it doesn’t have to be a spouse. Your pension doesn’t form part of your estate so you don’t need to include it in your Will, you just nominate who you want the pot to go to and let your provider know. Review your choice regularly, especially if you have multiple pension pots. Pension pots are not subject to inheritance tax, but if you’ve already started drawing down your pension (ie taking money out) this cash will form part of your estate so it may attract inheritance tax.
Who can inherit a defined benefit pension (final salary)?
If someone with a defined benefit (final salary) dies before taking their pension, most schemes will pay out a lump sum, the Money Advice Services says this is usually between two and four times annual salary. If they were under the age of 75 when they died, this lump sum is tax-free as long as the beneficiaries claim it within two years. If they were already retired, what happens depends on the rules of the individual pension scheme – some will continue paying something to the surviving spouse or dependents.
Who can inherit a defined contribution pension?
For those with a defined contribution pension, again, the rules depend on how old the saver was when they died. If you die before the age of 75, whoever inherits your pension usually won’t have to pay income tax on the money, but they will if you die aged 75 or over. The beneficiary may be able to choose whether to take the money out as a lump sum, or keep it invested and draw down an income. Read 'What happens to my pension when I die?'
Who can inherit an Annuity?
For those with an annuity, the income will usually stop when you die, although it may continue if the small print specifies the annuity includes a ‘guaranteed period’ during which it keeps paying out to the beneficiaries. If you think you would want to pass on an annuity to someone after your death, you’d need to choose a product which includes this option.
Who can inherit an ISA?
A spouse or civil partner can inherit their partner’s ISA allowance when they die, this will be either the value of the ISA when they died, or the value of their ISA when it is closed. This means ISAs keep their tax-efficient status even when the saver dies, taking into account that couples may have saved together from joint money over their lifetimes. The rules don’t apply to cohabiting couples who are unmarried or not civil partnered, however. You can leave your ISA to someone else, but they would have to pay inheritance tax on it if your total estate is worth more than £325,000. Read our article 'What happens to my ISA when I die?'.
Key things to consider before taking out a pension or ISA
Before you open an ISA or a pension, there are a few questions to ask yourself so you can choose the right product for you.
When do you need the money?
If you are saving or investing with a specific goal in mind, you might need to get at your cash before retirement age, in which case an ISA will probably be a better bet. ISAs work well for the mid to long-term. So, if you're saving for a goal that's five years into the future, for example, an ISA could be a good option.
Alternatively, a pension locks your money away until you're at least 55 (57 from April 2028). This could be a good option if you want to save for the long term without the temptation of accessing your savings.
Can you benefit from employer contributions?
Under the Pensions Act 2008, every employer must provide a workplace pension for qualifying staff through a government initiative titled 'auto-enrolment'.
To be eligible for auto-enrolment you must be:
- at least 22 years old
- under the state pension age
- earning at least £10,000 per year
It is possible to opt out of the scheme however, if you are employed you should definitely take advantage of this as it is a great way to turbocharge the growth in your savings. So, in this case, a pension would probably be the best option.
How flexible do you want your investments to be?
A self-managed SIPP or an investment ISA may be easier to rebalance than a workplace pension scheme administered by a pension provider, over which you have less control.
If you're happy to let a manager take care of your investments, then a workplace pension scheme that your employer contributes to can be a good option. But, if you want the choice that a self-managed SIPP offers, then you may need to look elsewhere.
How much money will you need to retire?
You’ll also need to think about the level of income you'll need in retirement, and whether the contributions you are making to your ISA or pension, and the underlying investments, will potentially deliver the growth you require. To work out how much you will need to be comfortable in retirement, try our pension calculator.
The pension income needed in retirement has gone up in 2024 as a result of the cost of living crisis. Find out how much you need to retire for a minimum, moderate, and comfortable life according to the PLSA to help you start planning.
If you’re not sure whether you need a pension or an ISA, why not have both? You use them for different purposes and reap the benefits of each. Check out our best-buy tables to get help choosing ISAs and pensions.
Further reading
If you still need additional help and guidance, take a look at the following articles:
- What is a SIPP and how does it work?
- How big does your pension pot need to be?
- What is the best Stocks and Shares ISA?
- Which are the best ethical Stocks and Shares ISAs in the UK?