Is a pension a better option for saving than an ISA?

Published by The Moneywise Team on 31 May 2011.
Last updated on 30 July 2012

Pensions piggy bank

Q: I'd like to save for my five-year-old daughter's retirement. I understand the virtues of stocks and shares individual savings accounts and the likelihood of growth over the long term, but would I be better off opening a pension, rather than saving in an ISA?

A: Francis Klonowski is principal of Klonowski & Co in Leeds.

The junior ISA - christened JISA - launched on 1 November 2011 may attract attention for children's savings.

However, I suspect you may not be eligible because your daughter was born at a time when child trust funds were being offered. Both these accounts raise a dilemma for parents, as the child becomes entitled to the money at 18  and you can't control how it is used.

So you need to decide whether you can accept this or would prefer to control when your daughter gets the money, and how much she gets at a time, especially if you wish to save for her retirement.

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The main difference between an ISA and a pension is how you're taxed.

With pensions, you enjoy tax relief when you put money in. For example, if you invest £100, it becomes £125 in the pension fund as the provider claims back basic-rate tax relief.

As for ISAs, you'll get your tax benefits when it comes to drawing down your money. For example, when you take out money from a cash ISA, you don't have to pay any income tax on the interest you've earned.

When you withdraw money from a pension, you can only withdraw 25% as a tax-free lump sum - the rest has to provide some form of income, which is taxable.

Beyond that, you can invest in the same types of funds in both plans, and both benefit from tax-free growth.

Generally, though, I would only consider pension savings for someone this age if all their interim needs, such as university fees or a house deposit, have already been covered.

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