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Should you invest in a pension or an ISA?

You want to give yourself the best chance of financial freedom in the future. But it can be tough to know what to do with your money.

Here, we explore the pros and cons of private pensions and stocks & shares ISAs to help you decide which one – or whether a combination of both – might be right for you.

Remember, if you have a workplace pension, this should always be the first place you save for your retirement. You can find out more about how pensions work here.

And keep in mind that the value of tax benefits will depend on your circumstances and tax rules may change in the future.

When do you want to access your money?

Pensions

Putting money into a private pension can give you peace of mind that you’re getting prepared to live the lifestyle you want beyond work.

Because pension funds are invested in various assets – including shares and bonds – for a long period of time, your money has the opportunity to grow.

To give your retirement pot the best chance to grow, pensions are locked away so you won’t be able to access your money until at least age 55 – or age 57 if you were born after April 1971.

These days, most pensions include income drawdown as a way of taking money from your pension whenever you like after your 55th (or 57th) birthday.

Stocks & shares ISAs

Unlike a pension, putting your money in a stocks & shares ISA means it’s not locked away until you’re at least 55. This gives you the potential to do more with it, be it taking a sabbatical to go travelling, starting a new business, or something else entirely.

Keep in mind that if you spend the retirement savings you’ve put in an ISA while you’re still working, it means you’ll have less to retire on when you finally stop working or be forced to work for longer.

However, being able to access your money when you want does give you the opportunity to re-invest it in something else. For example, using it as a deposit to buy a rental or holiday let property could potentially provide long-term income as well as capital growth.

Remember, you should still invest for at least 5 years. And with investing, there's always a risk you might get back less than you put in. So if you’re in a hurry to access your cash, you may end up selling your investments at a low point in the market, meaning you could lose money.

What about tax?

No matter what stage of life you’re at, the more money you’re able to put aside, the more chance you’ll have of living the lifestyle you want in the future.

But it’s worth knowing about the tax benefits of pensions and ISAs, as these can have a big impact on the amount you’ll end up with.

Pensions

The government lets you pay in up to 100% of your earnings into pensions, or £40,000 each year, whichever is lower. Before making any large contributions, it’s a good idea to speak to a financial adviser to make sure you’re doing the right thing.

Pension providers will reclaim basic rate income tax on your contributions. For example, if you put £20,000 into a pension, the government will add a further £5,000 in tax relief and so you’ll have £25,000 invested for your future. And if you pay more than the basic rate, you could reclaim additional tax relief.

As your pension grows there is no capital gains or income tax to pay on the pension fund and because of the tax relief, you’ll have a bigger initial sum invested compared to an ISA.

When you retire, you can take a quarter of your pension pot tax-free. Some pensions let you do this automatically each month and others whenever you need it. After that, you’ll have to pay income tax on the remainder, just as you would on your employment income.

Stocks & shares ISAs

You can save up to £20,000 a year in an ISA in the 2021/2022 tax year. It’s worth trying to make the most of this tax-free allowance as well as your pension savings.

You’re most likely to have paid income tax on any money you pay in to an ISA. However, as it grows, you’ll pay no tax on capital gains and dividends when you cash it in.

What about your estate?

If you’ve saved well throughout your life, you’ll want to know you can pass your money on to loved ones after your death. So, how is the money in a pension or ISA treated when you die?

Pensions

You decide who you’d like to receive your pension when you die and your estate won’t pay any inheritance tax on it.

Each of your beneficiaries will receive their share of your pension pot. They each decide how to invest the pot they have inherited and when to draw an income or lump sums from it.

They will pay no income tax on these withdrawals if you die before age 75. If you die age 75 or older, the withdrawals they make from the pension will be liable to income tax.

A beneficiary can even leave any remaining pension fund to their children or others on their death. So your spouse, children and even grandchildren can receive your pension pot and pay no inheritance tax on it.

Stocks & shares ISAs

Any ISAs form part of your estate and are liable to inheritance tax unless you leave your estate to an exempt person such as a spouse or civil partner. 

The amount you have in ISAs can be claimed as an additional ISA allowance by your spouse or civil partner when you die. This is the case even if you don't leave your estate to them.

If you or your spouse or civil partner has an estate that exceeds the inheritance tax threshold, pensions can be more attractive than ISAs when looking at what happens when you die.

The key takeaway: Why have one when you can have both?

It always makes sense to join your workplace pension and to benefit in full from any free money from your employer’s contributions.

If you can afford to, it also makes sense to pay into a pension and invest some funds in a stocks and shares ISA and that way you can enjoy the tax and long-term benefits of a pension and have some money set aside in investments that are more accessible.

If you’re considering putting more of your savings away for later life, we offer several ways to invest for your retirement.

As always, if you’re not sure what’s right for you and your money, you should talk to a financial adviser or visit the MoneyHelper website.

Pensions vs stocks & shares ISAs – at a glance

  Pensions Stocks & shares ISAs
Access
  •  Your money is locked away until you’re age 55 (or age 57 from 2028)
  • Choose to withdraw a tax-free lump sum and receive a taxable income or lump sum
  • Request a withdrawal whenever you want
  • Should always be seen as a long-term investment of at least 5 years
  • There's a risk you might get back less than you put in
Tax
  • Put away up to 100% of annual earnings, or £40,000, whichever is lower
  • Get an automatic 20% top-up from the government to your contributions
  • 25% of your pot is paid tax-free. The rest  is liable to income tax
  • Pay no tax on capital gains or income in your pension fund
  • Put away up to £20,000 tax free a year (in the 2021/22 tax year)
  • Pay no tax on capital gains and dividends
Estate
  • Your pension isn’t included in your estate so no inheritance tax is due
  • You choose who you’d like to receive your pension when you die
  • If you die before age 75, your beneficiaries won’t pay any income tax on the pension
  • If you die from age 75, each beneficiary will pay income tax when they receive the pension
  • The amount in your ISAs can be claimed as an additional ISA allowance by your spouse or civil partner when you die

Pensions vs stocks & shares ISAs – at a glance

  Access Access
Pensions
  •  Your money is locked away until you’re age 55 (or age 57 from 2028)
  • Choose to withdraw a tax-free lump sum and receive a taxable income or lump sum
  •  Your money is locked away until you’re age 55 (or age 57 from 2028)
  • Choose to withdraw a tax-free lump sum and receive a taxable income or lump sum
Stocks & shares ISAs
  • Request a withdrawal whenever you want
  • Should always be seen as a long-term investment of at least 5 years
  • There's a risk you might get back less than you put in
  • Request a withdrawal whenever you want
  • Should always be seen as a long-term investment of at least 5 years
  • There's a risk you might get back less than you put in
  Tax Tax
Pensions
  • Put away up to 100% of annual earnings, or £40,000, whichever is lower
  • Get an automatic 20% top-up from the government to your contributions
  • 25% of your pot is paid tax-free. The rest  is liable to income tax
  • Pay no tax on capital gains or income in your pension fund
  • Put away up to 100% of annual earnings, or £40,000, whichever is lower
  • Get an automatic 20% top-up from the government to your contributions
  • 25% of your pot is paid tax-free. The rest  is liable to income tax
  • Pay no tax on capital gains or income in your pension fund
Stocks & shares ISAs
  • Put away up to £20,000 tax free a year (in the 2021/22 tax year)
  • Pay no tax on capital gains and dividends
  • Put away up to £20,000 tax free a year (in the 2021/22 tax year)
  • Pay no tax on capital gains and dividends
  Estate Estate
Pensions
  • Your pension isn’t included in your estate so no inheritance tax is due
  • You choose who you’d like to receive your pension when you die
  • If you die before age 75, your beneficiaries won’t pay any income tax on the pension
  • If you die from age 75, each beneficiary will pay income tax when they receive the pension
  • Your pension isn’t included in your estate so no inheritance tax is due
  • You choose who you’d like to receive your pension when you die
  • If you die before age 75, your beneficiaries won’t pay any income tax on the pension
  • If you die from age 75, each beneficiary will pay income tax when they receive the pension
Stocks & shares ISAs
  • The amount in your ISAs can be claimed as an additional ISA allowance by your spouse or civil partner when you die
  • The amount in your ISAs can be claimed as an additional ISA allowance by your spouse or civil partner when you die