Pensions versus Isas - is one a better option?

Published by Rebecca O'Keeffe on 08 October 2013.
Last updated on 08 October 2013

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This is essentially the dilemma investors face when choosing between an Isa and a pension. If you can afford it, both have their advantages. If, like most of us, you're securing your financial future one step at a time, the decision might be less clear cut.

The Isa benefits are clear: they offer full control over your investments and unlimited access; they're easy to understand and are ideal for disciplined savers. For people looking for savings and investments that are tax efficient (tax free in many cases), with no need to declare them on your tax return, and with no further tax to pay on any income you receive, an Isa is a perfect choice.

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In terms of tax considerations alone, however, pensions qualify as the most efficient investment out there. Higher-rate taxpayers get up to 40% tax relief on contributions, with additional taxpayers receiving up to 45% tax relief. The ability to withdraw 25% cash, tax free, on retirement, also make pensions highly tax efficient. Many employees also benefit from employer's contributions on top, sometimes on a rising scale with increased personal contributions.

In addition, because of the way pension contributions work to reduce your taxable income, you could end up qualifying for additional working/child tax credits, bringing you further financial benefits. And while some people don't like the fact you can't access your money until a certain age, others see it as a critical step towards achieving long-term financial security.


So is there a clear-cut winner? In short, no. The answer depends on your circumstances.

Where your company contributes to a pension, this is a huge benefit. If you and your employer each make a 5% contribution, the tax advantages definitely add up.To make a £100 contribution you'll only need to pay in £40, as up-front tax relief and your employer's contribution will cover the rest. For a higher-rate taxpayer you can claim back a further 20%, so you only need to contribute £30 to get an overall contribution worth £100 – an impressive rate of return.

Even if you or your partner are not working, each individual can contribute up to £3,600 a year to a pension and get 20% tax relief – so a £3,600 investment only costs you £2,880. And because everyone has a personal allowance, it can be highly tax-efficient to aim to have some additional income in retirement.

Higher-rate taxpayers who may become lower-rate taxpayers in retirement are also obvious candidates for making the most of their pension contributions. If you're a regular, disciplined saver who wants the flexibility and easy access of an Isa, and who also realises the long-term benefits of having an income that is free from further tax and is not declarable, then an Isa is attractive.

It is also useful to note that the government has meddled far less with Isas, but has continued to change pension rules year after year.

Whatever your strategy, remember both Isas and pensions are simply tax wrappers.It's the underlying investment decisions that make the most difference.

Many people view pensions entirely differently from Isas, when it comes to what they invest in - whereas in reality there's no difference in this regard, especially if you opt for a self-invested personal pension (Sipp), because low-cost Sipps offer the same choice and flexibility as self-select Isas.

However, making the decision to invest is what really matters. Using your tax allowances is just a bonus with the additional benefits of limiting how much of your hard- earned money Chancellor George Osborne and his cronies get their hands on.

Rebecca O'Keeffe is the head of investment at Interactive Investor. Email her at

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