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ISA vs. pension

This is an article about ISAs and how they relate to investing in general.

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ISA vs pension

Similar in some ways, different in others

ISAs and pensions are both considered to be ‘tax efficient’ but there are significant differences.

Pension contributions are taken out of your pay packet before income tax is paid. Your pension pot then avoids tax until you retire. However, after retirement your pension income is taxable.

Money put into ISAs is taken from your income (or savings) after tax. It’s only subsequent growth of that money that is tax free, after it is nested inside the ISA.

So pensions don’t get taxed on the way in, but are subject to tax on the way out (when you draw your pension). ISAs are the reverse. They get taxed at the outset (if you pay income tax) but not on the way out, when you withdraw money.

Individual tax circumstances vary, but for many people pensions are likely to be more tax efficient, especially higher-rate taxpayers.

However, ISAs are more flexible because you can access your money any time. With pensions, the money is generally locked away until you reach retirement age. That isn’t necessarily a bad thing. It could be tempting to dip into ISA savings you earmarked for retirement – something you might later regret.

If you are thinking about ISAs as a way of saving for retirement, be aware of the pros and cons before deciding in favour of one or the other. You may consider seeking specialist advice, as the most appropriate choice will not be the same for everyone.

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