If you have some extra cash savings ready for investing at the end of the financial year, what’s best – a pension or an ISA?
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Both offer tax-efficient saving, but deciding which one offers the best benefits is tough.
Pensions and ISAs are not either/or investments, but different ways to reach the same goal.
Few savers have enough cash to max out their £40,000 a year pension allowance and the £20,000 a year ISA savings cap.
Besides, plumping for one over the other would probably be unwise.
Pension savers benefit from a government top-up of the money they pay in, tax free growth of funds and a 25% tax-free lump sum.
It’s also easier to get at pension money with the advent of pension freedoms for those who are aged 55 or over.
Mix and match
But pension money may receive tax breaks going into a pension, but after the lump sum, savers must pay income tax on their withdrawals.
ISA savers get no tax breaks putting money into the wrapper, but the fund does grow tax free and can be accessed at any time without the worry of a further tax bill.
There’s no 25% tax-free lump sum promise with an ISA – the only tax benefit is fund growth.
Having a mix of ISA and pension savings helps investors keep their funds together in a pension without diminishing them by paying tax.
Spending ISA savings first means more tax-free fund growth within a pension, but the big difference is inheritance tax should a saver die with unspent funds in a pension or ISA.
Pension funds are outside of the deceased’s estate for IHT, but ISA savings are not.
That means no 40% IHT against an unspent private pension fund and tax planning opportunities for those inheriting the money.
Paying tax on unspent pensions
| Payment | Type of pot | Age saver died | Tax usually paid |
| Most lump sums | Defined contribution or defined benefit | Under 75 | None |
| Most lump sums | Defined contribution or defined benefit | 75 or over | Income Tax deducted by provider |
| Trivial commutation lump sums | Defined contribution or defined benefit | Any age | Income Tax deducted by provider |
| Annuity or money from a new drawdown fund (set up or converted and first accessed from 6 April 2015) | Defined contribution | Under 75 | None |
| Money from an old drawdown fund (a ‘capped’ fund or a fund first accessed before 6 April 2015) | Defined contribution | Under 75 | Income Tax deducted by provider |
| Annuity or money from a drawdown fund | Defined contribution | 75 or over | Income Tax deducted by provider |
| Pension provided by the scheme | Defined contribution or defined benefit | Any age | Income Tax deducted by provider |
Source: Department of Work and Pensions
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