Pension vs ISAs: which is better?

Should you have a pension or an ISA (or both?)

Many people have built up sizeable pension pots in the hope that they will see them through retirement.

However, there are alternative savings vehicles available that could be considered, such as individual savings accounts (ISAs).

Here we explain how ISAs and pensions work, their pros and cons, and compare their key features.

Learn more: ISAs vs savings accounts: which is better for you?

What are the tax benefits of pensions and ISAs?

Both pensions and ISAs offer a great way to protect your retirement wealth from tax - they are both exempt from capital gains tax and tax on dividends. 

However, there are also differences. Pensions benefit from up-front tax relief, which adds up, especially if you’re a high earner. But, on the other hand, ISAs are more flexible, especially if you want to retire early. Pensions are typically locked away until you turn 55 (rising to 57 in April 2028).

Ultimately, a mixture of pension and ISA investments will suit many people. Both are great for protecting your wealth from the tax man, but they differ.

ISAs are more flexible, while pensions are great for boosting your long-term wealth. Tax-relief means you’ll get an immediate boost, which is especially valuable for high earners.

Ultimately, it’s worth speaking to a financial adviser, who can help you decide on the best strategy for you and your financial goals.

Here is a summary of the main tax differences between investments held inside or outside an ISA or pension.

What is upfront tax relief?

One of the main benefits of a pension vs an ISA is that you get income tax relief on any money you invest.

Here’s how it works:

Once your money is invested, the tax treatment is similar. Both ISAs and pensions protect your income from capital gains tax and tax on dividends.

However, don’t forget that there is often more tax to pay on pensions in retirement.

What are the investment limits?

Pensions have different limits regarding how much you can invest and still receive tax relief.

• Pension allowance: Currently £60,000 or 100% of annual earnings. This tax relief limit applies to total contributions from the individual and their employer.

• Pension allowance for non-earners: If you have no UK earnings or earn less than £3,600 a year, you can still contribute up to £2,880 each year and get tax relief, which would total contributions up to £3,600.

• Tapered annual allowance: Under this rule, your annual allowance reduces by £1 for every £2 of ‘adjusted income’ you earn above £260,000. Adjusted income means your total income, including any money you or your employer have added to your pensions, less any taxable lump sums you’ve received.

• Money purchase-annual allowance: Once you start making tax withdrawals from a pension, the annual allowance is reduced to £10,000.

• ISA limit: The annual contribution limit is currently £20,000 in total, but you can split this across other types of ISAs such as cash, stock and shares, innovative finance and lifetime ISAs. The cash ISA limit will fall to £12,000 for those under age 65 from April 2027.

• Junior ISA: With a junior ISA, you’re saving on behalf of a child, so the £9,000 junior ISA allowance is separate from your adult ISA allowance - if you wish, you could max out both.

• Lifetime ISA: Lifetime ISAs are only available to those aged 18-39. You can contribute up to £4,000 per tax year, which is topped up with a 25% bonus paid by the Government. They can be used to buy a first home or for retirement. They will be replaced with a new type of account from April 2028.

Previously, there was a ‘lifetime allowance,’ the maximum amount you could build up in your pensions without paying extra tax. 

However, this has now been abolished, meaning there is no longer an upper limit on the total value of pensions you can accumulate without facing additional tax charges.

What about employer contributions?

Perhaps the biggest difference between pensions and ISAs is that a pension is usually set up by your employer. You’ll also benefit from employer pension contributions, which can give your wealth a big boost over time.

It is also possible to set up your own personal pension, which can be a great option if you are self-employed or want to top up your workplace pension.

In contrast, ISAs are completely separate from your workplace and can only be set up by individuals. This means you won’t receive any additional employers’ contributions to your ISA - it’s all down to you.

Should I use a pension or ISA first?

For most people, the answer comes down to whether you want to prioritise tax relief now or flexibility later.

If your employer offers matched pension contributions, it is almost always worth maximising these before directing any additional savings into an ISA. Employer contributions are essentially free money that you forfeit by prioritising an ISA instead, no ISA can replicate this benefit.

Beyond employer matching, higher and additional-rate taxpayers generally benefit from directing surplus income into a pension first. The upfront tax relief means the government is effectively topping up your contributions at your marginal rate, making a pension the more efficient vehicle for long-term wealth building at higher income levels.

For basic-rate taxpayers, or those who value flexibility, the case for prioritising an ISA is stronger. If you are likely to need access to your savings before age 57, whether for a career break, early retirement, or an unexpected expense, building up an ISA alongside your pension gives you a tax-free accessible pot to draw on without touching your pension early.

The sequencing that suits many people is: first, contribute enough to your pension to capture full employer matching; second, use your ISA allowance for accessible, flexible savings; and third, return to topping up your pension if you have further surplus income and the tax relief makes it worthwhile.

It is worth noting that this decision is closely tied to your income, tax position, and timeline, all of which can change. A financial adviser can help you review the right balance year by year and adjust your approach as your circumstances evolve.

What happens when you retire in the UK?

How easily you can access your money when you retire is a key factor in deciding between an ISA and a pension.

Accessing your pension

With a pension, you normally have to wait until age 55 to access it, although this is due to rise to 57 in 2028 in the UK.

You can then take up to 25% of your pension pot as a tax-free lump sum. Most people use the remainder to provide a taxable income. 

Many options are available, including purchasing an annuity, which provides a guaranteed income for the remainder of your life or a specific period, or using flexible drawdown instead. This is where you take money out of your pension as needed, while leaving the rest invested so it can (hopefully) continue to grow.

Accessing your ISA

You can withdraw cash from an ISA at any age. If you have a flexible ISA, you can pay the money back in within the same tax year without affecting your ISA allowance.

All withdrawals from ISAs are completely tax-free, and you can choose to make a big one-off withdrawal or a series of smaller ones, which can help with both short-term savings and longer-term retirement planning.

What happens to my pension or ISA if I die?

If you die before drawing your benefits, your employer may provide a “Death in Service” benefit. This is a form of insurance and is often based on a multiple of your salary.

You may have also accumulated pension benefits that can be passed onto your loved ones. The way it works depends on the type of scheme.

For personal pensions and defined contribution workplace pensions, this is simply the fund value on the day you die (Make sure you keep your expression of wishes form up to date so the pension providers know where to distribute your pension).

Currently, this value is normally not included as part of your estate, which is useful for anyone with an inheritance tax liability. However, this will change from 2027, when defined contribution pensions will be counted as part of your estate and will be subject to inheritance tax.

If you die before age 75, your beneficiaries can take an income or lump sum, free from income tax, up to the limit of the lump sum death benefit allowance (LSDBA). However, if you die after age 75, any lump sum or income taken will be subject to income tax.

If you die with a defined benefit (often called final salary or average salary pension) the situation is different. Your spouse may receive a percentage of your pension, depending on the terms of the scheme.

ISAs operate differently from a pension. If you die, the entire value of the ISA is passed on under the terms of your will. However, funds passed on will lose their protected tax status once they are distributed. Your spouse can apply for an additional ISA allowance known as an "Additional Permitted Subscription" in their own name, equal to the value of your ISAs. This allows them to “reshelter” assets in their own name.

Bear in mind that when your spouse passes away, this money can then be passed on to your children. This isn’t always possible with pensions, as defined benefit schemes typically only provide death benefits to your spouse.

So, is a pension or ISA best?

There are benefits and drawbacks to both investment types. Ultimately, a mixture of both will suit many people.

A financial adviser can help you decide on the right balance between pensions and an ISA, so you minimise your tax bill and maximise your income for retirement.

Both ISAs and pensions provide a tax wrapper to protect your wealth from capital gains tax, dividend tax and income tax on interest. This means you won’t have to pay tax on gains, dividend income or interest payments inside your pension or ISA.

Pensions have generous tax relief upfront, but you are then subject to numerous rules and restrictions about how and when you can take your money out. You are also taxed on most of the money you take back out.

Pensions are particularly beneficial for higher-rate taxpayers who get a higher rate of tax relief on initial contributions.

ISAs are much simpler and more flexible, but you are held back by the lower annual investment limit.

In practice, a combination of ISAs and pensions will be suitable for most people. It is important to understand the ins and outs of any investment you choose so you know what to expect when you retire.

Get expert financial advice

Ultimately, the choice between pensions and ISAs depends on your financial goals, tax situation, and flexibility needs.

For most people, a balanced approach using both options can offer a blend of tax efficiency and accessibility, helping you build a robust retirement plan that suits your individual needs.

Let Unbiased quickly match you with a financial adviser for expert financial advice on choosing between a pension and an ISA to meet your financial goals.