The difference between an ISA and a pension

When it comes to retirement, you may be wondering what the best option is for you and your savings when you take a step back from work.

If you’re stuck choosing between an ISA or a pension, there are a number of crucial differences that you need to be aware of when building a financial plan.

We’ve asked Paul Darley, Managing Director to share his advice on ISAs and pensions, to hopefully help give an idea about what option is best for you.

Take it away Paul…

Planning for the future is key, and we all want to be able to retire knowing a pot of savings has been built up in advance. It’s up to you how you choose to save for the future, but we understand it’s a pretty big decision to make.

You may be debating between an ISA or a pension, but can’t seem to lean more to one option than the other. Both are ways to invest for the future and both have significant, yet different, tax benefits. I’ve outlined some points below, to help you choose the best and most appropriate option for your personal finances and situation.

If you’re looking for a long-term investment

Paying into a pension considerably reduces the amount of tax you pay, as money paid into a pension pot is eligible for tax relief, due to the government encouraging people to save for their retirement. The pension provider will claim back 20% tax from HMRC for every £1 you contribute to a pension. You can almost view it as being similar to receiving a bonus on your savings, and can help the funds grow faster compared to other investment options.

There’s also an added benefit that if you are employed, you will be auto-enrolled into a workplace pension scheme whereby your employer must contribute towards it. It’s essentially free money that’s put into your pension pot, that’s being invested wisely to fund your retirement.

Accessing your money

Unlike a pension, whereby you can’t access your savings until the age of 55, with an ISA you are able to access funds, whether you have a cash or stocks and shares ISA, at any time you like. This means you can have much more flexibility if you ever needed to access money for potential projects, hobbies or life events that require a significant amount.

If you have a short-term financial goal in mind, or a change you want to make to your lifestyle, an ISA could be the better option to suit you, as you are also able to earn some interest on top of your savings.

The Annual Allowance

Both pensions and ISAs have an Annual Allowance limit, which is the maximum you can pay into either over a tax year.

You may have heard in the recent Spring Budget that the Annual Allowance for pensions will increase from £40,000, to £60,000 from 6 April 2023 to encourage people to save more towards retirement. Our Paraplanner, Jack Farmer, recently wrote about this in his Spring Budget Report.

ISAs on the other hand have a lower limit, £20,000, which resets at the start of each new tax year. You can spread this limit over the four types of ISA (cash, stocks and shares, innovative finance and lifetime) but it’s important to note that you can only pay into one of these types of ISA in the same tax year, with lifetimes ISAs having their own limit of £4,000.

Think about inheritance rules

Whilst planning which saving route to go down for your retirement, it’s good to be aware of inheritance rules. Any investments you put into an ISA will become part of your estate for Inheritance Tax purposes, unless it has been decided to be left to an exempt beneficiary, such as a spouse or civil partner for example.

Any pension pot that you pass onto your family won’t usually be subject to Inheritance Tax as it won’t form part of your taxable estate. However, it’s worth checking with your pension provider that this applies to you and who you’d like to inherit these savings.

I still can’t decide… Can I use both?

There are pros and cons for both- a pension is best if you want to add to your retirement pot as a long-term investment. The tax relief granted on paying into a pension is also an extremely attractive benefit.

However, you may want to access your funds before you plan to retire, and this is possible when using an ISA.

If you’re still on the fence, there is the option to utilise both. The amount you chose to invest in a pension and an ISA will of course depend on your financial circumstances, but combining them allows you to benefit from a tax-efficient wealth of both saving and investing.

It’s important to remember that due to the ever-changing economy, the value of your investments can go up and down regularly, which can influence the decisions you make.

We’re here to help

At Wealth Experts, we’re here to help put your financial plans first, whatever they may be. If you would like to gain some advice on using a pension or ISA for your future, you can speak to one of our friendly advisors by calling 01782 345 100