Individual Savings Accounts (ISAs) vs Pensions

What is the maximum you can pay in? 

For the current tax year, an individual can invest up to £20,000 into an ISA of which no more than £4,000 can go into a Lifetime ISA each tax year. Flexible ISAs allow the individual to replace any withdrawals they have made, within certain limits. 

For a pension, in theory, there is no limit on the amount of contributions that can be made by an individual, their employer and/or any third party. However, there is a limit on the tax relief that can be received on personal contributions and a tax charge if total contributions in a tax year go over the annual allowance. See section below on What is the tax difference between an ISA and a pension? 

What age limits apply? 

An individual must be aged 18 to open an (adult) ISA. 

A Lifetime ISA may only be opened under the age of 40 but payments can be received until the individual reaches age 50. Money can be withdrawn from the age of 60 or earlier, if buying their first home or terminally ill, without a 25% withdrawal charge. 

A child is eligible for a Junior ISA, if they are under 18 years old (and don’t have a child trust fund). The parent/legal guardian will apply for the account unless the child is over 16. Withdrawals can’t be taken before age 18 (unless the child is terminally ill). 

A pension can be opened at any age but for a child, who is unlikely to have any relevant UK earnings, personal contributions will be limited to £3,600 a tax year. A provider will usually insist a parent or guardian opens the pension on their behalf while under age 18 (16 in Scotland).   

Although no upper age limit under legislation, personal contributions to a pension don’t attract tax relief on or after age 75. Due to this some pension providers don’t accept contributions after age 75. 

Does the individual have to be resident in the UK to open an ISA or a pension?

An individual normally must be resident in the UK to open an ISA.  

However, if they are a Crown employee serving overseas (or a spouse or civil partner of one) who is paid out of the public revenue of the UK – this is usually a diplomat or a serving member of the armed forces then they can also take out an ISA.

To open a pension, most UK providers require the individual to be habitually resident in the UK. This normal means that they are living in the UK on a permanent basis. To get tax relief on personal contributions the individual must be a relevant UK individual. Some pension providers only accept personal contributions that attract tax relief. 

Some providers also don’t allow pensions and/or ISAs to be opened for US persons.  

What is the tax difference between an ISA and a pension? 

Pensions are sometimes known as being EET (exempt, exempt, taxed) while ISAs are TEE (taxed, exempt, exempt). 

This is a very simplistic way to summarise the tax situation and it's slightly more complicated than that. 

ISA

Are ISAs subject to income tax?

The money invested in an ISA will usually already have been taxed (as they will probably come from someone’s taxable earnings). The individual doesn’t have to declare income or gains in an ISA on their tax returns and funds can be taken from the ISA tax free (although there will be a withdrawal charge of 25% if the individual takes a withdrawal from a lifetime ISA and they are not buying their first home, are under age 60 or they are not terminally ill).  

Are ISAs subject to inheritance tax?  

Money held in an ISA forms part of the deceased person’s estate on death. If the money from the ISA is inherited by their spouse/civil partner no inheritance tax will be payable as it’s covered by the spousal inheritance tax exemption. However, it will form part of the spouse/civil partner’s estate on their death if any of the ISA money remains.

If the ISA money is passed to anyone other than the spouse/civil partner, such as an adult child, it will be included in the value of the estate and may be liable for inheritance tax. If the value of the estate is more than the inheritance tax nil rate band of £325,000, tax of 40% may be payable on any excess.

Pension

Are pensions subject to income tax?

Tax relief on contributions made by the individual (or a third party who is not their employer) can be received up to 100% of their relevant UK earnings (or £3,600, if greater). Employer contributions can receive corporation tax relief subject to the wholly and exclusive for the purpose of the trade rules. See our article: Company and employer contributions and tax relief.

All pension contributions (and pension benefits built up in a defined benefit scheme) in a tax year count towards the annual allowance. This is currently £60,000. If contributions go over this, the individual will be subject to the annual allowance charge.  

Their annual allowance may be lower if they are a higher earner (see Tapered Annual Allowance) or they have triggered the Money Purchase Annual Allowance. 

When benefits are taken from the pension, generally 25% will be tax free. However, any tax-free lump sums will be measured against the Lump Sum Allowance (and Lump Sum and Death Benefit Allowance) and benefits above the Lump Sum Allowance will be subject to income tax at the individual’s marginal rate.

Investments by registered pension schemes are generally exempt from income or capital gains tax. HMRCs Pensions tax manual: PTM121000 - Investments: essential principles has more information on this.

Are pensions subject to inheritance tax?* 

Pension funds are normally inheritance tax exempt on death if the scheme is written under trust (and most are) and the trustee/administrator has discretion on who to pay the benefits to. Certain plans can be subject to inheritance tax unless placed under trust, as these are paid directly to the estate or a named person, but if paid to the spouse/civil partner no inheritance tax will be payable as it’s covered by the spousal inheritance tax exemption. The following types of plans could be subject to inheritance tax:

• Section 32 (buy-out plans)
• retirement annuity contracts (Section 226)

However, if the tax-free cash and other withdrawals have already been taken from a pension, they may be in the estate on death, and be subject to inheritance tax.

If on death, the benefits are held in a beneficiary/nominee drawdown plan, the benefits remain outside the beneficiaries/nominee’s estate.

Beneficiaries who continue with drawdown can nominate someone to receive the funds following their death, allowing the funds to pass through the generations while still being in the pensions tax wrapper and therefore outside the survivor’s estate for inheritance tax.

Individuals in poor health could be subject to inheritance tax if they transfer their benefits to a new plan or they contribute to a pension, and they die within two years. More information can be found in our case study in our Pension death benefits article.

Third party contributions to a pension can be used to reduce inheritance tax by reducing the value of the estate before death. The contributions are classed as gifts for inheritance tax, and the usual exemptions apply, so £3,000 can be paid as an exempt gift. If it can be shown regular contributions can be paid out of income without affecting the standard of living, they will be exempt.

If none of the exemptions apply and the individual survives for at least seven years after making a contribution, that contribution will be inheritance tax free as this is gift will be a potentially exempt transfer.

*From April 2027, it is the government’s intention to bring unused pension funds and death benefits within the value of an individual’s estate for inheritance tax purposes.

What is the difference on death between an ISA and a pension? 

Death benefits under an ISA, the proceeds are normally paid income tax free. Individual Savings Accounts (ISAs): If you die 

Death benefits are paid income tax free under a pension if the individual dies under age 75 and the benefits are paid out within two years and below the deceased’s Lump Sum and Death Benefit Allowance. If the individual dies on or after age 75, then death benefits are taxable at the beneficiaries’ marginal rate of income tax. 

When can ISA and pension benefits be accessed? 

ISAs  

Withdrawals from ISAs can be made at any time. The exception to this is for Junior ISAs, where withdrawals can’t generally be made unless the child is terminally ill, before they are 18 years old.  

For Lifetime ISAs, withdrawals can be done but they will be subject to a 25% withdrawal charge unless the individual is: 

• buying their first home
• aged 60 or over 
• terminally ill. 

Pensions 

Benefits from pension schemes can’t normally be taken before 55 (increasing to 57 in 2028) although they may, subject to scheme rules, be able to be taken earlier if the individual is in ill-health/serious ill-health (subject to conditions) or has a protected lower minimum pension age. 

Can you contribute to more than one ISA or pension in a tax year? 

Individuals can subscribe to more than one cash ISA, one stocks and shares ISA, one innovative finance ISA in a tax year. 

However, an individual can only subscribe to one Lifetime ISA in a tax year, and for junior ISAs only one cash ISA and/or one stocks and shares ISA can ever be opened. 

There is maximum subscription of £20,000 in a tax year to all ISAs (of that only £4,000 can go into a Lifetime Allowance ISA. 

Individuals can contribute to more than one pension in a tax year. However, there is an overall limit on tax relief on personal contributions of 100% of relevant UK earnings that an individual can make in a tax year to all of their pensions. Also, if total contributions—including those from the employer, the individual, and any third parties—plus any relevant benefits accrued under a defined benefit scheme exceed the annual allowance (currently £60,000, though this may be lower for certain high earners or those who have flexibly accessed their pension), an annual allowance charge will apply. 

Can an employer contribute to an ISA or a pension?

An employer can contribute to a pension. In fact, they may have to where the pension is used for auto enrolment. Employer contributions can receive corporation tax relief subject to the wholly and exclusively rules.

In contrast, ISAs can only be funded by the individual. Employers cannot contribute directly to an individual’s ISA. While some employers may help facilitate ISA payments for their employees, this does not offer any tax or financial advantages to the employer. 

Can you transfer an ISA or pension?

Yes. 

An ISA can be transferred to the same or a different type of ISA although there will be a 25% charge if transferring a Lifetime ISA to a non-Lifetime ISA. A full or partial transfer can be done of the current and previous tax year’s subscriptions. 

A pension can be transferred to another registered pension scheme or an overseas pension scheme (meeting the conditions for a qualifying recognised overseas pension scheme). If the fund is uncrystallised, then a partial or full transfer can be done.  

A drawdown arrangement may also be transferred but there are conditions such as a drawdown arrangement can only be transferred to another drawdown arrangement. The transfer cannot be split into two or more drawdown arrangements, nor can only part of the drawdown arrangement be transferred. However, part or all of the drawdown arrangement can be used to purchase an annuity.  

The transferred drawdown arrangement must be paid to a new arrangement that does not hold any other funds, nor can any further funds be added to it.   

What can ISAs and pensions invest in? 

It will depend on what type of ISA and pension they are invested in and also the rules of the ISA/pension scheme. 

A cash ISA can only invest in cash so is effectively just a bank account with tax advantages.  

A stocks and shares ISA can be used to invest in investments such as stocks and shares, corporate bonds, government bonds, unit trusts, life assurance policies and OEICs. A full list of possible investments can be found at: Stocks and shares ISA investments for ISA managers.

Pensions generally invest in investment funds but SIPPs and SSASs (known as member directed pension schemes) also allow investments in such things as commercial property, subject to conditions. More information about pension investments can be found at: PTM121000 - Investments: essential principles

ISA vs Pension: quick comparison of key features

It’s worth noting that this table lists what is allowed under legislation. A provider may not offer all these options.