THAT moment I’m cornered at the BBQ with ”Should I put my money in a pension or an ISA?”
Well, it’s like a wagyu burger versus a beer – both can be enjoyable but both do very different things.
Let’s start with the ISA. It’s the financial equivalent of a well-stocked fridge. You can put your money in, take it out whenever you like, and you don’t get taxed on the way out. The annual contribution limit is £20,000. Once your ISA is up and running, all growth inside it is free of income tax and capital gains tax. The big downside? No tax relief when you pay in.
A pension, on the other hand, is more like a chest freezer in the garage. You can’t get to it without a bit of effort, and the rules say you can’t open it until you’re 55 – rising to 57 from April 2028 – unless you’re seriously ill or have special protection.
Every pound you put in gets topped up by the taxman at your marginal rate. If you’re a basic-rate taxpayer, £80 magically becomes £100. For higher-rate taxpayers, £60 becomes £100. Additional-rate taxpayers see a bigger uplift again. If you later draw the money in a lower tax band, the potential benefit over an ISA can be significant – in some cases more than 40 per cent extra for the same net cost. And if your employer is willing to add to the pot, sometimes matching your contributions, that’s free money, which makes the pension freezer even more tempting.
Both pensions and ISAs let your investments grow free of income and capital gains tax while they’re inside. With pensions, 25 per cent of what you withdraw usually comes out tax-free, with the rest taxed as income at whatever rate applies to you at the time.
ISAs have that £20,000 annual cap – simple, easy, done. Pensions have a headline annual allowance of £60,000 in 2024/25, though this can shrink to £10,000 for very high earners or those who have already tapped into their pension flexibly. You can only get tax relief on what you actually earn (or £3,600 gross if this is more than you earn).
Then there’s the question of what happens when you die. ISAs are straightforward – the full value is part of your estate for inheritance tax. If you have a spouse or civil partner, they can inherit an extra ISA allowance, but otherwise it’s open season for the taxman. Pensions have been the cleverer option here as discretionary schemes have normally kept them outside your estate for inheritance tax, with the added benefit of being income-tax free for beneficiaries if you die before 75. After 75, they pay income tax on withdrawals. That long-standing inheritance tax edge, though, is changing – from April 2027, most unused pensions will be included in your estate for inheritance tax pending legislation.
On a pure numbers comparison, pensions can have the upper hand, especially if you pay in at a higher rate of tax than you expect to pay on the way out. Even at the same rate in and out, the combination of tax relief and the 25 per cent tax-free element can leave you better off than an ISA. Add employer contributions, and the advantage can be hard to beat. But pensions give you less flexibility on access, and that’s the price you pay for the boost.
There’s also a hybrid worth a mention: the Lifetime ISA. Available to those under 40, it allows you to save up to £4,000 a year with a 25 per cent government bonus. Withdraw after 60 or for a first home worth up to £450,000 and you keep the bonus; take it for anything else and you lose the bonus plus pay a penalty. It suits some younger savers, but it’s rarely a replacement for a pension when employer contributions are on the table.
So which tin of biscuits do you choose? If your employer offers to match pension contributions, the freezer wins hands down – doubling your money before it’s even invested is hard to beat. If you’re self-employed, dislike being locked in until your late 50s, or want a pot you can dip into without triggering tax, the fridge starts looking appealing. The real answer is to have both – ice cream in the freezer and milk in the fridge.
If you have an investment query, please call 01872 222422 or email info@wwfp.net
Peter McGahan is the Chief Executive Officer of independent financial advisers Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.