We're constantly being told that we need to be saving more for our future, and for good reason, but one of the biggest issues for investors is how to save more for their future. For long-term savings, the choice is essentially between two types of tax-efficient wrapper - the pension and the individual savings account (ISA).

Flexibility and Protection

The number one difference between the two routes is that they're targeted at different things. An ISA is an all-purpose savings vehicle aimed at nothing in particular, for people to build up a nice pot of dough that they can use to do what they like, if and when the opportunity presents itself. It's a sort of second tier reserve fund for when you suddenly decide you want to provide a deposit on all four of your children's first homes. Ouch!

So ISAs need to be supremely flexible and they are. You can invest in a huge range of assets, from cash to shares (depending on which bit of the ISA it's in and there's more about that here), and you can withdraw the money and do what you like with it, when you like.

Pensions, on the other hand, are targeted very specifically at providing you with a retirement income. The Government sees this as a very honourable thing to be doing and it really wants your pension savings to make it that far, so it provides the pension with considerable protection.

If you lose your job, then you'd have to spend the bulk of your other savings before qualifying for welfare, but your pension would remain sacrosanct. Similarly, if you were made bankrupt, then your pension savings would be safe while anything you had in an ISA, or elsewhere, would get gobbled up by your creditors.

But the Government, bless it, is also intent on protecting your pension from you. So you can't just withdraw the money and spend it before you reach retirement and, when you eventually get there, the bulk of your pension savings have to be used to buy an annuity.

Annuities are renowned for their low returns, but that's because they're also a very reliable way of providing you with an income for the rest of your days. The Government really doesn't want your retirement income to run out or it (which actually means the rest of us taxpayers) might have to pick up the bill, thus spoiling all the hard work in getting you to save in the first place and helping your pension savings to reach that far.

Impenetrable Tax Issues

The other big difference between pensions and ISAs is in their tax treatment. On the whole, however, these are not as great as you might think and all but impossible to quantify.

The easiest way to think about it is to imagine that the Government only wants to tax your money once, so long as you use one of its special savings vehicles. So, with any of your earnings that you put into a pension it says 'fine, I won't tax that now, instead I'll tax it when you take the income in retirement'. With your earnings that you might save into an ISA, it says 'ok, I've already taxed those earnings, so I won't charge you any more tax on the ISA'. All things being equal, this should amount to the same thing.

For example, look at the position for a higher rate taxpayer who earns £100 gross (that is, £60 after tax), saves it and gets 7% growth for three years before drawing income at a rate of 5%. Because we're multiplying by the same numbers, just in a different order, each year's income will be the same, for the ISA and the pension:

This position, though, is confused by a couple of factors, which tend to give pensions a slight advantage. First of all, you're likely to have a lower tax rate in retirement than you do in your working life (subject to what the Government does with taxes), so that would make the upfront tax benefit of the pension slightly better.

Secondly, although things like cash and bonds get full income tax relief in an ISA, the income tax benefits of holding shares in an ISA aren't quite so good. This is because the company has already paid tax on your slice of its profits, before it gets to pay you a dividend, and you don't get any of that back.

A bit of both

All in all, pensions have a bit of an edge over ISAs, in terms of tax, and potentially in terms of welfare and bankruptcy protection, but the flip side is that they're only any good for providing a very safe retirement income. For a large part of your long-term savings, that's probably just what you want, so a pension should suit very well.

However, if you think you might want to blow the money on a whim, use it for deposits on your children's homes or leave it to someone in your Will, then an ISA's more likely the answer. For most people, it probably makes sense to have a bit of both. After all, you won't be able to cough up for those house deposits if you haven't already secured a comfortable retirement.