The advantages and disadvantages of saving into a pension scheme versus an ISA

By Gill Philpott, Tax and Trust Specialist 

It’s that time of year again when ISA top ups come to the fore with the looming tax year-end deadline of 5^th April 2021. Clients often ask us – ‘What is the difference between saving into a pension versus an ISA?’. The answer can be a difficult one to determine without the support of an expert in these fields. It’s this complexity that sometimes leads to people missing out on the full benefits of each of these savings mechanisms in any given tax year.

This year more than most, you may find that you have more time to look at your savings options, or you may find your financial circumstances have changed and you have more cash available and want to put it into a pension or ISA. You have time now to work with your financial adviser to do what is best for you. In this podcast and supporting article, our Tax expert Gill Philpott explains the differences and the benefits between a pension and ISA.

Both ISAs and personal pensions can offer you tax benefits, but how do you know what the best fit for your individual needs and circumstances might be?

In this article, we look at some of the advantages and disadvantages of both savings options, in order to provide you with a better understanding of these investments.

Firstly, we look at the tax position of ISAs and pensions in our comparative table below:

While contributions to personal pension schemes benefit from tax relief and boost the value of the contribution paid, accessing income from the fund does have tax consequences. In contrast, ISAs do not have the upfront tax benefits that contributing to a pension scheme has, however the funds built up into an ISA can be accessed entirely tax-free.

It is likely however, that the tax benefits associated with contributing to a personal pension scheme and the ability to take a 25% tax-free lump sum from the scheme will, if comparable returns are achieved across both investments, favour the pension route for tax purposes.

So, if a tax advantage lies with the pension arrangement, what advantage does an ISA have? The ISA does provide tax efficiencies, but its distinct advantage over the pension fund is its flexibility in accessing funds. All the funds in an ISA can be accessed tax-free without having to wait until the age of 55. This can lend the ISA to being useful in funding life goals before the age of retirement; repaying the mortgage to enable early retirement, taking a dream holiday for that significant birthday, helping the children onto the property ladder, or contributing to the grandchildren’s first car etc.

Another advantage is that over a working lifetime an annual contribution of £20,000 to a pension will see the pension fund grow to the extent it is more than likely to exceed the pension lifetime allowance. This restricts the amount that can be put into a pension without incurring a tax charge. An ISA however has no such lifetime allowance limit.

ISAs can be a useful option if pension contributions are limited due to high earnings, or a restricted pension contribution allowance of £4,000 when pensions have been flexibly accessed.

There are a range of ISA accounts available to suit different circumstances and saving goals, these include the Lifetime ISA, the Junior ISA, Cash ISAs, Stocks and Shares ISAs.

The decision between contributing to a personal pension or an ISA will ultimately depend on your individual circumstances. In many cases, a combination of investment into both ISAs and pensions may be used together as part of a financial plan.

Ultimately, the best option will depend on individual financial circumstances, objectives and personal preferences. Your Ascot Lloyd financial adviser will always be happy to help navigate the best options for you.

Please contact your financial adviser directly or request a call back to discuss any requirements you may have – we would love to help.