Which is the best - pensions or ISAs?

by Tony Granger of www.taxinsider.co.uk

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 up front. If you are a basic rate taxpayer, you make a net contribution of £800 and £1,000 is invested, with HMRC contributing £200 or 20 per cent.

Higher rate taxpayers receive an additional 20 per cent (£200 in this example) and additional rate taxpayers 30 per cent (£300).

If you have no income, the maximum you can contribute is £3,600.

With taxable income, you can contribute a maximum of 100 per cent of your 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 per cent tax credit on dividends is not reclaimable (the same with ISAs).


You can access 100 per cent 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 per cent 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.

 ISAPension Fund
Tax-free growthYesYes
Contribution limits – maximumUp to £11,280 per annumUp to £50,000 per annum
Tax relief on contributionsNoYes
Income taxableNoYes
Children investingYes - up to £3,600Yes - up to £3,600 if no income
Tax-free lump sum100 per cent at any time25 per cent from age 55
AccessAny timeFrom age 55
Investment rangeBroadMore flexible choices
Inheritance taxNot shelteredSheltered
Maximum age to contributeNoneAge 75
InsolvencyNot protectedProtected
HMRC contributionNoneAt least 20 per cent of the gross contribution
Short-term savingsYesNo
Invest ISA into pensionYesN/A
Invest pension into ISAN/ATax-free cash portion only
Retirement savingsYesYes

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 per cent from HMRC – whether a taxpayer or not.

However, if you are 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 per cent 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:

  1. Utilise your annual ISA allowance of £11,280 in the 2012-13 tax year, or lose it.
  2. For long-term savings, consider pension contributions, as the investment returns could be higher with tax reliefs.
  3. The tax rules for pensions, in particular, can be complicated. As always, seek advice from a suitably qualified and experienced professional adviser, if necessary.

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Published on: June 1, 2012

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