ISA vs Pension: Which is best to save for retirement?
By Boring Money
16 Sep, 2024
When it comes to saving up for retirement, there are lots of different ways you can stash money away, but it can be a real pickle deciding which type of account is really the best one for you. Many of us are guilty of simply settling with a Pension because that’s what everyone else does, forgetting that ISAs can also be a great vehicle for saving for your later years too. But which is the better way to save? And more importantly, which is best for you?
What's the difference between an ISA and a Pension?
First things first: What’s the difference between a Pension and an ISA? You’ll have heard both terms being thrown around in discussions about retirement, but let’s nail down the details before we start comparing the two.
What is an ISA?
ISA stands for ‘Individual Savings Account’ and is a type of bank account that you can use to put money into for the purpose of saving. There are several different types of ISA out there and there are also different ways that you can use the money while it’s sitting in your ISA. Let’s walk through this.
Types of ISA
There are 4 main types of ISA, but each one has slightly different features, so you may find that one suits your needs better than others. You can save up to a maximum of £20,000 in ISAs every tax year. This can be spread across more than one type of ISA, however, you can only set up and pay into 1 of each type of ISA per year.
For example, if you open a Stocks & Shares ISA in the 2024-25 tax year, you can only pay into this Stocks & Shares ISA and you cannot set up another Stocks & Shares ISA until the next tax year. However, you can set up a Cash ISA (as it's a different type of ISA) and pay into this one too, as long as you don't exceed your annual allowance across both of them.
Let’s explain the main types of ISA on the market.
A bank account you can use to save money tax-free. As of the 2023-24 tax year, you can save up to £20,000 into a Cash ISA every tax year without paying a single penny of tax. You must be over the age of 18 to open one. Any interest earned on the money in a Cash ISA is free from Capital Gains Tax. You can read our full guide to Cash ISAs here.
Another bank account you can use to save money tax-free - but this time while investing! As of the 2023-24 tax year, you can save up to £20,000 into a Stocks & Shares ISA every tax year without paying a single penny of tax. You must be over the age of 18 to open one. Any gains (profits) or dividends earned from investments in a Stocks & Shares ISA are free from Capital Gains Tax. You can read our full guide to Stocks & Shares ISAs here.
A bank account you can use to save money either to purchase your first property or as part of your retirement fund. The UK government will give you a 25% cash bonus every 12 months! But as of 2023-24, you can only save up to £4,000 every year. You must be between 18-39 to open one, but you can keep paying in until you're 50. Read our full guide here for more on the rules, eligibility and pros and cons.
A bank account you can use to save money tax-free on behalf of a child. As of the 2023-24 tax year, you can save up to £9,000 into a JISA every 12 months without paying any tax at all. The child you are saving for can’t access the cash until they reach 18 years of age. Just like a standard ISA, the money can either be stored in cash or invested in stocks and shares. You can read more about Junior ISAs in our full guide here.
What is a Pension?
A Pension is a type of long-term savings account that you can use to put money away for when you’re retired. You can only access the money in a Pension once you're over the age of 55 or you're retired. There are several different types of Pension, and you can withdraw the money in different ways too, either: in a lump sum; “drawdown” in increments; or purchase an annuity to receive a regular income. Let’s take a look at the different kinds of Pension.
Types of Pension
There are 3 main types of Pension, but each one is different, and you can have as many as you want – although you can only save the equivalent of 100% of your annual income or £60,000 per year tax-free (whichever is the lowest).
A State Pension is a regular income provided by the UK government which some people can access once they reach State Pension age. As of 2023-24, this is currently 66. Not everyone is eligible, and not everyone gets the same amount, as entitlement is based on your record of National Insurance contributions. You can read more about how the State Pension works in our full guide here.
A Workplace Pension is a pension scheme which is paid into by you and your employer. Contributions are typically taken directly from your monthly wages and your employer will boost this with a contribution of their own. Most people are automatically enrolled on a Workplace Pension. You can have either a Defined Contribution Pension (made up of your monthly contributions from your salary) or a Defined Benefit Pension (a predetermined sum agreed upon in your employment contract).
A Self-Invested Personal Pension (also called a SIPP or Private Pension) is a type of pension which you can set up in addition to other schemes to boost your retirement income. They’re similar to Workplace Pensions except you set them up yourself. You can pay in with regular contributions or make one-off payments whenever suits you, and you can access the money from the age of 55. Read more about how SIPPs work and how you can use them in our guide here.
ISA vs Pension
Now that you’ve got a broad understanding of ISAs and Pensions, let’s compare the two. Which is best for saving up for retirement? Are ISAs more tax-efficient? And what about inheritance when you pass away?
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