Should you put money into an ISA or pension?

Gareth Smith, Senior Retirement Planning Lead
29 January 2024

Do you wish you could be more prepared for your financial future? When it comes to this topic, it can feel like there are a lot of things to think about. And sometimes it can be tough to know what's best for you.

Two options which often go head-to-head when it comes to future planning are ISAs and pensions - and for good reason. Both of these could play an important role in making sure you're not paying more tax than you need to.

ISA vs pension - which is a better investment?

It’s a question we get asked quite a lot, but it doesn’t have to be an either/or answer.

Personally, I’m a firm believer that ISAs and pensions can both play valuable roles in a financial plan. Plus, it very much depends on you and your circumstances – which is why it’s worth asking yourself a few questions:

• What are your savings goals?
• How long do you have before you need to use these savings?
• How much money do you need to retire?
• Do you feel on track to achieve your financial goals?

Pensions and ISAs both have their own set of specific features and one of the best things you can do is to understand the main differences between them.

So with that in mind, let's take a closer look at ISAs and pensions together.
 

How much can you pay into an ISA or pension without paying tax?

Pensions

The most you can pay into a pension each tax year (without paying tax) stands at £60,000. However there are some things to be aware of:

• You can only pay in up to 100% of your relevant earnings. So, if you earn £30,000 annually, you can't personally pay more than £30,000 into a pension in that tax year (after tax relief).
• If you don't have any earnings, you can still pay in up to £3,600 gross (before tax) in a tax year.
• Higher earners may get a lower annual allowance depending on their tax status.

ISAs

An ISA could be one of the best ways to grow and look after your money over the long term. You can save or invest up to £20,000 each tax year, with any growth or interest you earn free from tax.

What happens if you don't use your pension or ISA allowances?

If you don’t use your annual ISA allowance by 5 April each year, it’s gone and can’t be carried over.

But with a pension, you can carry forward any unused annual allowances from the last three tax years.

This could be a valuable option if you’ve a sum of money to invest and haven’t paid a lot into pensions over the last few years – providing you have the earnings to cover such a large contribution.

What's the best ISA for you?

There are several types of ISAs to choose from but the main two are Cash and Stocks & Shares.

• Cash ISAs are like other savings accounts. Depending on the terms, you can pay in and withdraw as often as you like, whilst earning interest on your money.
• If you have longer-term goals, and can commit your savings for at least five years, a Stocks & Shares ISA could be right for you if you're willing to take some risk with your money.

Interest rates have really shot up since the end of 2021, meaning you could now earn a lot more from your savings.

What are the tax advantages of paying into an ISA or pension?

Remember, with an ISA any growth or interest you earn is tax free. 

As for pensions - well, it's a given that they are very important for preparing your retirement. And there are a few tax-efficient benefits which you might not be taking full advantage of.

For example, by simply paying money into a defined contribution pension you could instantly boost your wealth through tax relief.

Let’s say you wanted to save £500 a month into a pension;

• Basic rate taxpayer - receives 20% tax relief. This means it would actually cost you £400 a month to save £500.
• Higher rate taxpayer - can claim 40% tax relief. This means it would actually cost you £300 a month to save £500.
• Additional rate taxpayer - can claim 45% tax relief. This means it would actually cost you £275 a month to save £500.

If you’re a higher or additional rate taxpayer, you’ll need to claim the extra 20% or 25% via self-assessment. Once you turn 75 years old, you can still pay into a pension but you will not receive tax relief on any contributions.

Even if you already have a workplace pension, the tax benefits on offer could mean it’s worth thinking about setting up an additional pension. 

Learn more about our Pension planning.

Can you access an ISA or pension when you need the money?

When it comes to withdrawing from both pensions and ISAs there are a few things to think about:

• Most ISAs don’t have any tax charges to withdraw. However, some Cash ISAs may charge a penalty if you withdraw before the end of a fixed term. We always recommend you invest for at least five years before withdrawing from a Stock & Shares ISA. This is to give your money time to grow across different market conditions.
• You can only access your pension when you reach 55 years old (rising to 57 years old in 2028).
• Even then, only 25% of the total pot is tax-free to take (capped at £268,275). For anything above this, you pay tax in line with current income tax rates.

It’s wise to carefully manage when and how much you withdraw from your pension. If you were to take it all in one go, you could face a big tax charge.

What about inheriting an ISA or pension?

Inheritance tax is always a hot topic. And over the next few years, more people are expected to leave behind an inheritance tax liability.

• Money held in an ISA forms part of your estate on death so could be subject to inheritance tax.
• If you die before you’re 75 years old, your family - or chosen beneficiaries - can inherit your pension fund tax-free (up to the amount of £1,073,100). If you die after 75 years old, they will only have to pay tax at their marginal income tax rate to receive these funds.

Pensions could prove a useful way of planning your legacy, so your loved ones get to inherit more of what you want them to have.

Learn more about our Inheritance Tax planning.

Your next move

At Skipton Building Society, we’re proud to offer you a FREE My Money Review service. It’s a friendly conversation between you and one of our experienced colleagues about you - and what you want in the future. And, if needed, we could arrange a follow-up appointment with one of our expert Financial Advisers.

Whatever your situation, we believe the tax-efficient benefits of ISAs and pensions are too important to ignore.