Is it better to have a pension or ISA?

Do you wish you could be more prepared for your financial future?

One of the most effective ways of taking care of your money is to make sure you’re not paying more tax than you need to.

Both an ISA and a pension could play valuable roles in your financial plans, but it can be tough knowing which approach might be right for you. So – let’s look at ISAs and pensions together.

Pension versus ISA annual allowances

A bar chart comparing the annual tax allowance for Pensions and ISAs.

What is the annual allowance for UK pensions?

The most you can pay into a pension each tax year (without paying tax) stands at £60,000.

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

How much can I save in an ISA each year?

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.

Cash ISA vs Stocks and Shares ISA

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.

The great news is interest rates have really shot up since the end of 2021, meaning you could now earn a lot more from your savings.

Read our ISA guide to find out more about how ISAs work.

Investing in a Pension or a Stocks and Shares ISA does mean placing your capital at risk, as their value can fall as well as rise.

The good news is Skipton has a team of financial advisers who can help you assess your feelings to risk and reward.

What happens if I don’t use my pension or ISA allowance?

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

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

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

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How does tax relief work with pensions?

Having a pension is very important for preparing you for retirement. But you might not yet be taking full advantage of the tax-efficient benefits available to you.

With a defined contribution pension, for example, tax relief could instantly boost your wealth – just by paying in.

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

  • Basic Rate Taxpayer - You get 20% tax relief – this means it would actually cost you £400 a month to have £500 a month saved
  • Higher Rate Taxpayer - You can claim 40% tax relief – meaning it would actually cost you £300 a month.
  • Additional Rate Taxpayer - You can claim 45% tax relief – resulting in an actual cost of £275 a month.

To get the full tax relief you’re allowed, higher and additional rate taxpayers have to claim the extra 20% or 25% via self-assessment.

Even if you already have a workplace pension, the full tax benefits available means it might be worth considering setting up an additional pension.

Learn more about our Pension planning.

Accessing funds - pension versus ISA withdrawals

It’s worth remembering, there are tax considerations on how you withdraw from your pension or ISA.

  • Firstly, you can only access your pension when you reach 55 (rising to 57 in 2028).
  • Even then, only 25% of the total pot is tax-free to take (capped at £268,275). With the other amount, you pay tax in line with current income tax rates.

This means it’s wise to carefully manage when and how much you withdraw from your pension. For example, if you took it all in one go, you could face a big tax charge.

Most ISAs don’t have any tax charges to withdraw. But it’s strongly recommended you wait at least five years before withdrawing from a stocks and shares ISA. This is to allow it time to grow across different market conditions.

What about inheriting an ISA or pension?

It’s expected more people will leave behind an inheritance tax liability over the next few years.

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

This means 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.

So, is an ISA or pension right for you?

It really depends on you. And what you want to achieve with your money.

To help you consider your next steps it might be worth asking yourself:

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

At Skipton Building Society, we’re proud to offer you a My Review service. It’s a friendly conversation between you and one of our Savings consultants 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.

Important information

Stock market based investments are not like Building Society savings accounts. The value of your investments can go down as well as up and you may get back less than you invested. The tax treatment of investments and pensions depends on personal circumstances. Tax rules may change in the future. If you take too much income too quickly from your pension fund then your fund could be depleted or run out altogether.

Still unsure?

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The way you manage your money could determine your financial future. But would knowing more about your ‘money personality’ help you change it? Take our quick Financial Fitness quiz to find out which type you are and the steps you could take to get where you want to be.