Clash of the tax-efficient titans

Posted by Adrian Lowcock in Portfolio management category on 20 Jun 19

Recent relaxations in pension rules mean that there are more similarities than ever between ISAs and pensions. So with the underlying investment options being very similar, which is right for you? This week, we place the two titans of the UK savings landscape head to head. 

Employer contributions

With workplace pension auto-enrolment now firmly established for those in employment, a key benefit of pensions is that employers have to contribute on your behalf (provided you earn over a certain amount). Some employers will increase the amount they pay if you do the same, so it's important to make the most of what’s on offer.

With ISAs on the other hand, any contributions have to come from you and cannot come from an employer.  So making the most of your workplace pension schemes is a good start.

Tax relief on your contributions

The main advantage of a pension over an ISA is the fact that pension contributions will generally entitle you to tax relief. If a basic rate taxpayer pays in £800, the government would top it up so you actually get £1,000 invested. If you pay tax at a higher rate than the basic rate (currently 20%), then you can usually claim the additional tax relief from HM Revenue & Customs. The rules on tax relief can be complicated and there are limits to the amount you can pay in with the benefit of tax relief. You can learn more by reading our simple Pensions Tax Relief guide. You can also find out how much tax relief you might be entitled to by using our tax relief calculator.

With ISAs you don’t get tax relief on your contributions with the exception of the Lifetime ISA, where you can get a 25% government bonus on a limited amount of savings each year. Otherwise, if you pay in £800 you get £800 in your ISA, so pensions come out top again.

Tax on your investments

Once your money’s invested in a pension or an ISA, any interest or dividends generated are exempt from income tax. Likewise, any gains realised when selling your investments are free of Capital Gains Tax.  Pensions and ISAs are both very effective ways to avoid tax on any income or capital gains your investments make for you. This helps you grow your wealth more quickly.

Tax on withdrawals

With an ISA, when you come to take your money out, either income or capital, there’s no tax to pay. This keeps things simple and you don’t need to declare it to the taxman.

With a pension, on the other hand, there’s potentially tax to pay when you take your money out. You can normally access 25% of your pot tax-free but the rest is subject to income tax at your highest marginal rate.  So whilst you get tax relief on money being put into a pension, you are taxed on the way out. 

This can work in your favour if you pay a higher rate of tax when you make your contributions than you expect to pay when you take your money back out again. 


Once your money’s invested in an ISA, you can take it out however and whenever you want (subject to your provider’s terms and conditions). 

With pensions however, except in cases of ill-health, you cannot access your money until you are age 55, which is expected to rise to 57 by 2028.

Pension pots can now be accessed flexibly. You can make one off or regular withdrawals of any amount straight from your pot or use the money to buy an annuity (an income for life). You can even take out the whole of your fund in one go if you want to although this could have adverse tax implications and is unlikely to be in your interests if your pot needs to last throughout your retirement.

Overall ISAs offer more flexibility in terms of accessing your money although for some, locking your money away to prevent you spending it before retirement might be a good thing!

Lifetime Allowance 

There is no limit on the amount of pension savings you can build up. However, there is a restriction on the amount of pension savings, from both contributions and investment returns, which a person may build up in a tax-favoured environment; this is known as the lifetime allowance. There is a tax charge if the total value of your pensions is more than the lifetime allowance at the time you make a withdrawal. 

The lifetime allowance for the tax year 2019/20 is £1,055,000 and it is likely to increase in line with inflation at the end of the current tax year.  

ISAs on the other hand have no overall limit on the amount you can build up. You can grow your ISA pot to be as large as you like.

Estate planning and Inheritance Tax

Money held in ISAs forms part of your estate (unless you leave it to an exempt beneficiary like a spouse or a charity). It's therefore potentially liable to Inheritance Tax (IHT) on your death if your estate is over the IHT threshold. Ordinarily, pension funds aren’t treated as part of your estate and so will generally escape Inheritance Tax.

Other considerations

For high earners, pension contributions can have other advantages over ISAs.

One example relates to the fact that the personal income tax allowance (the first part of your income upon which you don’t pay tax) is gradually withdrawn if you earn more than £100,000. When totalling up your income against this threshold, your pension contributions can be deducted. A well timed pension contribution might allow you to rescue all or part of your personal tax allowance, further reducing tax on your other income. 

Pension contributions can also help if you’re facing a potential Capital Gains Tax (CGT) charge when selling an asset like a second property or investments held outside of ISAs or pensions. Capital gains are put on top of your other income when working out any tax due. Any part of the gain falling in the basic rate band is taxed at 10% and the balance at 20% (18% and 28% respectively if the asset is a residential property). For this purpose, the size of your basic rate tax band is increased by the amount of any personal pension contribution you’ve made during the year (including the government top-up), so you can boost your retirement savings and potentially save on CGT by making a pension contribution. 

For parents of young children, pension contributions are similarly deducted when considering the eligibility thresholds for tax-free Child Benefit and the government sponsored tax-free childcare scheme.

The reality is that there is no clear winner in the ISA versus pension debate. It all depends on your personal circumstances and when and how you need to be able to access your money. Of course, there’s no reason you can’t hold both and nothing stopping you from, for example, saving money in an ISA and putting it into a pension later to secure the benefit of tax relief (provided you’ve got sufficient scope to make contributions of a sufficient size). You can find out about the Willis Owen pension and ISA products here

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