3 Reasons Why Pensions Are Better Than ISAs (& Vice Versa)

A friend called me the other day for a bit of free advice. She realised that now she was in her thirties it was high time she took money a bit more seriously and planned for the future. She wanted to be tax efficient and put money away where she couldn’t be tempted to access it so didn’t think an ISA was appropriate but she hadn’t heard anything positive about pensions.

The simple answer was that she should do both but here are the 3 reasons I gave her why pensions are better than ISAs and the 3 reasons why ISAs are better than pensions.

The Case For Pensions

1. Pension contributions attract free money – As an incentive to save the Government gives tax relief on pension contributions. 20% gets applied, immediately so to have £100 invested you only need to pay £80. Higher rate tax payers get even more; 40% or 50% depending on your tax rate so to have £100 invested only costs £60 or £50.
2. You can save more into a pension – As of 6th April 2011 the maximum that can be invested into a pension to attract tax relief will be £50,000 pa. This compares to £10,680 for an ISA. Pension contributions can also be made on behalf of another person such as a child or grandchild, although the limit is £3,600.
3. Pension funds are free from IHT – Death before retirement enables a pension fund to be passed to a chosen beneficiary free of inheritance tax. In retirement the rules are slightly different with a top rate of death tax of 55% just being announded by the Government.

The Case for ISAs

1. The fund can be accessed at anytime – The earliest a pension fund can be accessed is 55 which is not much good if you need capital sooner. ISAs, on the other hand are accessible at anytime. This is a disadvantage if, like my friend, you don’t trust yourself to access it without absolute necessity.
2. They are free Income Tax – Income can be taken from an ISA fund free of income tax. This is a great means of providing income in retirement in addition to pension income which is taxed at 20%, 40% or 50% depending on total income for the year.
3. The whole fund can be taken as a lump sum – Pensions rules allow only 25% of the fund to be taken as a lump sum (tax free) with the balance being used to provide a (taxable) income. With ISAs the whole fund can be crystallised tax free.

So, both ISA and pensions have advantages and disadvantages. Ideally you will be able to maximise both annual allowances but this is not always possible. But, whatever you do, do something. Don’t proscratinate! Benefit from compound interest asap.

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