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Which is the Best - Pensions or ISAs?

Which is the Best - Pensions or ISAs?
Both ISAs and Pensions are tax efficient investment vehicles.  Both can be invested into broadly similar investment funds.  However, each has unique characteristics which, depending on your personal circumstances, will determine which one you opt for – or both.  Over 12 million people save into ISAs each year (HMRC statistics 2011).



ISA means Individual Savings Account.  In this tax year 2012-13, an individual can invest up to £11,280 into an investment ISA in stocks and shares, or £5,640 into a Cash ISA and the same into a stocks and shares ISA.  You can have a cash ISA from age 16 and an investment ISA from age 18. There is also the new ‘Junior ISA’ available from birth, with a maximum of £3,600 per annum that can be invested by parents for a child.

The ISA investment grows completely tax free, incurs no capital gains or income tax, and is accessible at any time – apart from a Junior ISA which is only accessible from age 18. 

 Tax on interest and capital growth is therefore legally avoided.  There is no tax relief on the ISA investment being made.



Pension contributions generally get tax relief upfront. If a basic rate taxpayer, you make a net contribution of £800 and £1,000 is invested, with HMRC contributing £200 or 20%.  Higher rate taxpayers receive an additional 20% (£200 in this example) and additional rate taxpayers 30% (£300).  If you have no income the maximum you can contribute is £3,600.  With taxable income, you can contribute a maximum of 100% of salary capped at £50,000 in this tax year.


The pension investment grows tax free; no income tax or capital gains tax is payable on investment income.  The 10% tax credit on dividends is not reclaimable (the same with ISAs).



You can access 100% of your ISA investment at any time (unless you have invested into a fixed term deposit account).  Your pension investment can only be accessed if you are age 55 and over.  You are limited to a maximum of 25% in tax free cash with your pension plan – the balance of your fund buys you a pension or annuity, which is taxable.


The table below sums up the ‘pros’ and ‘cons’ of investing into ISAs or pension funds.


                                                         ISA                              Pension Fund
Tax free growth                                Yes                                     Yes
Contribution limits –max.          Up to £11,280 p.a.           Up to £50,000 p.a.
Tax relief on contributions                 No                                       Yes
Income taxable                                 No                                       Yes
Children investing                     Yes – up to £3,600       Yes – up to £3,600 if no income
Tax free lump sum                    100% at any time              25% from age 55
Access                                           Any time                          From age 55
Investment range                            Broad                         More flexible choices
Inheritance tax                           Not sheltered                         Sheltered
Maximum age to contribute             None                                  Age 75
Insolvency                                 Not protected                        Protected
HMRC contribution                          None                           At least 20% of the

                                                                                         gross contribution
Short term savings – e.g.                Yes                                        No

mortgage deposit 
Invest ISA into pension                    Yes                                         -
Invest pension into ISA                      -                           Tax free cash portion only
Flexibility                                          Yes                                        No
Retirement savings                          Yes                                        Yes


Both ISAs and pension funds can be good investment choices depending on your objectives for the investments.  ISAs are more flexible, with less complicated restrictions and paperwork when it comes to investing.  Pensions can allow for greater contributions annually than ISAs, and have a guaranteed return on each contribution made of 20% from HMRC – whether a taxpayer or not. 


However, if saving in the short term and require access to funds at any time, then ISAs are more flexible for you (you have to wait until age 55 to access your pension fund and then only 25% is available to you as tax free cash).  Both ISA investments and pension funds are treated in the same way for tax purposes, with no income tax or capital gains tax payable on fund income or growth, and both can be used for retirement planning. 


Practical Tip :

(i) Utilise your annual ISA allowance of £11,280 in the 2012-13 tax year, or lose it.

(ii) For long term savings, consider pension contributions, as the investment returns could be higher with tax reliefs.

(iii) The tax rules for pensions in particular can be complicated. As always, seek advice from a suitably qualified and experienced professional adviser if necessary.


Tony Granger