Pensions vs ISAs
Discover how combining pensions and ISAs can create a flexible and tax-efficient retirement plan. Learn about the benefits, tax advantages, and strategies for using these savings options to build a resilient and comfortable retirement.
Saving for the future can feel daunting, but the UK government has made it easier with two main tax-efficient options: pensions and ISAs (Individual Savings Accounts). Each has its unique benefits and using these in combination can give you a flexible and resilient retirement plan.
Pensions are long-term savings plans designed to help you set aside money for when you retire or work less. They offer peace of mind and come with attractive tax advantages.
ISAs, often called ‘wrappers’, shield your investments and savings from tax. Unlike pensions, you can access your ISA funds anytime, not just in retirement. Investments within an ISA are exempt from income tax, capital gains tax (CGT), and tax on dividends, making them a smart choice for tax-efficient savings.
Pensions provide significant upfront tax benefits, especially for higher-rate taxpayers, as contributions can be deducted from your earnings for tax purposes. However, you typically can't access these savings until you turn 55 (or 57 from April 6, 2028).
In this article, we focus on ‘defined contribution’ pensions, where your pension pot grows based on your contributions and the performance of your investments.
Unlike pensions, ISA contributions are not tax-deductible, but they offer the flexibility to withdraw money whenever you need it. Plus, any withdrawals from an ISA are free from income tax, CGT, and dividend tax.
Using both pensions and ISAs can be a powerful strategy. Pensions offer long-term growth potential and tax relief, while ISAs provide immediate access to funds without tax penalties. This combination can help you manage life's uncertainties and save towards a more comfortable retirement.
Annual pension contribution limits
You can't usually invest more than £60,000 a year in a pension. If you have more to invest and have already made use of previous years pensions allowances, an ISA could be a great way to do so tax-efficiently during your pre-retirement years.
There are many ways to utilise ISAs and pensions to fund your retirement, and the best arrangement depends on your unique circumstances. Here are three illustrative examples:
1. Early retirement strategy: You could use your ISAs first in the early years of retirement and tap into your pension later. As things currently stand, this could offer inheritance tax advantages, as your pension remains outside your estate if you pass away before age 75, however, following the Autumn budget in October 2024 there are plans to make pensions subject to Inheritance Tax from April 2027.
2. Annual lump sums: You might decide to take annual lump sums from your pension, with 25% taken as tax-free cash and the remaining 75% taxed as income. You could supplement this with your ISA savings, which aren't subject to tax, helping to reduce your overall tax payments.
3. Tax-free cash allowance: If you need cash, consider withdrawing the full tax-free cash allowance from your pension (currently 25%). Use some of this as income in your first retirement year, invest some in an ISA for future use, and keep the rest in the bank for next year's spending or further ISA investment.
These examples are for illustrative purposes only, but, show how ISAs and pensions can be used in combination to maximise tax efficiency and meet different financial needs.
At Schroders Personal Wealth, we believe in regular reviews with a financial adviser. This helps ensure your financial plans stay aligned with your evolving circumstances and that you're making the most of available tax-efficient opportunities.
Pensions vs ISAs – at a glance
| ISA | PENSION | |
|---|---|---|
Age you can invest | From age 16 for cash ISAs, 18 for stocks and shares ISAs, 0 for Junior ISAs (JISAs) | Age 0 to 75 |
Age you can withdraw | From age 16 for cash ISAs, 18 for stocks and shares ISAs, 18 for Junior ISAs. At age 60 or to buy your first home for a Lifetime ISA . | From age 55 (age 57 after 6 April 2028), possibly earlier if you’re seriously ill and meet certain conditions. |
Amount you can invest each year | £20,000 for 2024/25 tax year, £9,000 for Junior ISAs | Usually (but not always) £60,000 or 100% of your UK Relevant earnings (whichever is the lower) for 2024/25 and 2025/26 tax years. |
Income tax – putting money in | You’ve already paid tax on the money you put in | Working taxpayers could benefit by directing earnings into a workplace pension, without having to pay income tax on amount input. This will also lower income overall, which could save even more on income tax |
Income tax – taking money out | No income tax to pay | 25% is tax-free, and there is income tax to pay on the rest |
Capital gains tax | No capital gains tax to pay | No capital gains tax to pay |
Inheritance tax | Included in your estate unless passed to a spouse or civil partner | Not included in your estate if you're under 75 (1). Counts towards heirs’ income tax if you’re aged 75 and above, beneficiaries will also be charged income tax at their own rate so potentially subject to dual taxation. |
Types of investment allowed | Cash, shares, government and corporate bonds, and investment funds | Cash, shares, government and corporate bonds, and investment funds |
Employer contributions | None | Auto enrolment for UK pensions requires employers to automatically enrol eligible workers into a workplace pension scheme and make contributions to their pensions |
Source:
(1) This is currently under review following the 2024 Autumn budget and may change from 2027 onwards
Important information
Fees and charges apply.
This article is for information purposes only. It is not intended as investment advice.
The different scenarios discussed are examples and what is right for each person will depend on individual circumstances.
Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.
The value of investments and the income from them can fall as well as rise and are not guaranteed.
The retirement benefits you receive from your pension plan depend on a number of factors including the value of your plan when you decide to take your benefits which isn’t guaranteed and can down as well as up. The benefits of your plan could fall below the amount(s) paid in.
