What are the differences between pensions and ISAs?

For a Individual Savings Account (ISA), the national annual contributions limit is £20,000. This annual limit applies to the total amount you can contribute across all types of ISAs. An advantage of an ISA, is that you have a massive tax break. The money gained or capital gained is all tax-free. This is different to normal investments. As any money gained is taxed under capital gains tax. However, from a pension you get a tax break from putting your money in there unlike an ISA.

Tax relief and Investment limits

When you contribute to a pension in the UK, you receive tax relief based on your income tax rate. Basic rate taxpayers (20%) get £20 added for every £80 pension contribution, making it £100.

So, although your ISA isn't taxed, if you wanted to save £80 per month on your ISA, you would have to write a cheque for £80.

As of the 6th of April 2024, the government will abolish the pension lifetime allowance. 

Lifetime allowances limit how much you can save in a pension with tax relief. However, there are restrictions on how much you can contribute each year, which is currently £60,000.

The old limit of £1,073,100 will be abolished. Aswell  the tax-free maximum lump will be frozen at £268,275. Anything above this amount will be taxed at the marginal rate. 

ISAs in the UK have an annual contribution limit of £20,000. This annual limit applies to the total amount you can contribute across all types of ISAs.

What happens when I retire?

Generally, you cannot take a pension until age 55.

You can then take a lump sum of 25% of your pension pot as tax-free (maximum £268,275).

The remainder is usually used to provide taxable income at the marginal rate. 

At 55, you can use income drawdown or buy an annuity for lifelong income. Which could provide income for the rest of your life.

You can cash from an ISA at any age and at any time. All withdrawals are entirely tax-free.

What happens if I die?

The spouse typically gets 50% of the pension in occupational pension schemes. Many occupational pensions pay death benefits to a spouse, but not to children.

Personal pensions pass 100% to heirs and are free from inheritance tax.

ISAs are quite simple. If you die, your entire ISA will be cashed in and paid to your spouse.

Summary

Many people consider holding a stocks and shares ISA a 'no-brainer'. Over time the stock market investments usually outperform cash savings.

Many avoid selling shares outside an ISA due to capital gains tax. This fear can lead to poor and costly decisions.

An ISA lets you buy and sell investments without considering UK income and capital tax implications.

ISAs offer flexibility, while pensions focus on retirement income. Many use both to balance short-term access and future security.