Contents

• Investing and tax treatment

• Tax treatment on entry and exit

• Access considerations

• Inheritance Tax (IHT)

• Comparisons between pension and ISA

• Comparisons between pensions and ISA on death

• Summary of differences
   

Investing and tax treatment

Invested funds in ISAs and pensions are both treated in a tax efficient way with no income tax or capital gains tax due on or in respect of the funds whilst they are invested. It is for this reason that ideally, where there is sufficient capital to invest, both an ISA and a pension should be considered together and before any other investments are considered. However, those with significant assets may consider other investment opportunities when planning for longer term wealth transfer such as investments in trust.

Employer funding may be relevant – an employer can fund a pension directly but can’t fund an ISA unless acting as an agent for an employee contribution (which is an administrative function only with no benefits).
 

Tax treatment on entry and exit

Despite similarities on tax treatment whilst invested, the tax treatment on entry and exit is an area where there is significant difference between an ISA and a pension. 

The maximum investment into an ISA is £20,000 a year and contributions to ISAs do not attract any uplift but pension contributions do. Note that Lifetime ISAs include a 25% government uplift similar to a pension, but this comes with some additional restrictions on the use. 

For a pension the rules are more complex, personal contributions up to a clients net relevant earnings (or £3,600 if higher) attract tax relief. The annual allowance of £60,000 effectively caps tax relief as higher levels of contributions will be subject to an annual allowance tax charge. Carry forward may be used in some instances to increase that limit. Some clients may be subject to a tapered annual allowance or where clients have started to access benefits the money purchase annual allowance may apply.   

Relief at source pension schemes receive basic rate of tax relief, even if the individual is not a tax payer, increasing the gross investment compared to an ISA. In addition, higher and additional rate tax relief may be applicable for pension contributions thus increasing the net gross contribution. Contributions to a net pay scheme result in immediate tax relief at marginal rate.

On exit usually up to 25% of the pension fund is payable free of any tax, capped by the lump sum allowance, with the remainder taxed as income. If pension funds are payable in the event of death before age 75 they are generally paid free of income tax although any lump sum payment in excess of the lump sum and death benefit allowance will be taxable as income in the hands of the beneficiary(ies). On death after age 75 all pension benefits are subject to income tax.    

All funds drawn from an ISA are free from income tax without any cap. 

Access considerations

Age considerations are relevant, both in terms of paying into and taking money from either investment. There is no minimum age for a pension investment but there is a minimum age for an ISA (18) however a Junior ISA can be used instead for children.

There is no maximum age for an ISA investment but pensions contributions no longer benefit from tax relief from age 75. Some pensions may still end at age 75 though this is no longer a requirement, so some pensions can continue until needed or can be left as death benefits. 

Access is a critical factor in that ISA funds can be accessed at any time, but pension funds can only be accessed (unless on ill-health terms or on death) from age 55 (rising to age 57 in April 2028). Clients that anticipate a need to access funds before the minimum pension age may benefit using an ISA or a combined strategy.

Clients that opt for a Lifetime ISA can access the ISA at any time but suffer a 25% charge if drawn before age 60 unless used to purchase your first home.

 

Inheritance Tax (IHT)

IHT planning may be a factor when deciding whether to invest in an ISA or a pension. Funds in an ISA are assessable for IHT purposes, but pension funds are until 6 April 2027 generally not assessed for IHT.

From 6 April 2027 most pension death benefits and unused pensions will be included in a client’s estate for IHT purposes. Whilst there may be some short-term considerations for deaths before 6 April 2027 where pensions will remain outside of the estate, most people will now be planning for pensions forming part of their estate.

Read our Pensions and IHT article for more detail on how pensions interact with IHT both now and from 6 April 2027.
 

Comparisons between pension and ISA

A mathematical comparison reveals that, taking into account the differences in tax treatment on entry and exit (assuming the funds are used during life, and not passed on death), an investment into a pension will deliver a better net result than the same investment into an ISA. For a lifetime basic rate tax-payer the difference in net returns is 6.3% in favour of a pension. 
 

Example 

Robin and Maurice are 55-year-old twins and are both looking to invest £20,000. They are both higher rate tax-payers but are likely to look to access their savings in 10 years’ time. Robin invests his £20,000 in an ISA but Maurice decides to invest in a pension instead. Over the 10 years invested the funds achieve growth of 3% per annum net of charges. Both are now basic rate tax-payers and take their funds as a lump sum. Basic rate tax assumed at 20%. 

Consideration	Robin's ISA	Maurice's pension
Amount invested	£20,000	£25,000 (with tax relief)
Amount available after 10 years (including 3% per annum net growth)	£26,878	£33,598
Tax payable	None	£5,040
Net amount payable after tax	£26,878	£28,558 (6.3% higher)

Maurice also received an enhancement to his income as a result of higher rate tax relief on the £25,000. However, if the taxable income (75% of the pension) for Maurice pushed him into a higher tax bracket then the advantage could be lost. Drawing the pension over multiple tax years can help to mitigate higher rates of tax.
 

Higher and Additional rate taxpayers benefit from additional tax relief that reduces the cost of making the £20,000 net contribution. Alternatively, with the same cost to the client (£20,000) they could make increased contributions to a pension. A higher rate tax payer could make a pension contribution of £33,333.33, or an additional rate tax payer could make a contribution of £36,363.64. Higher initial investment allows greater long-term growth. Many clients also pay lower tax rates in retirement than they do when making pension contributions, so benefit from maximising the tax relief upfront, and reducing tax rates in retirement.

Where a client can only fund one of either an ISA or a pension a balancing act is required to determine what is the right route to take. The mathematics point in the direction of a pension but the client’s objectives (particularly in relation to access to savings or the complexity of a pension) may mean that a pension is discounted in favour of an ISA despite the potential of a lower return overall.    

Many employed clients will also be enrolled into a pension scheme where their employer also contributes, so when employer contributions are factored in this can make the returns from a pension more favourable.
 

Comparisons between pensions and ISA on death

Currently as pensions are exempt from assessment to IHT (in most circumstances) then on death, pensions typically provide superior returns, especially where pension death benefits are free from income tax. From 6 April 2027, pensions are valued part of the estate and equally subject to IHT, but can still offer better returns.

Current (pre 6 April 2027) position

Consideration	ISA	Pension - death pre 75	Pension - death after 75
Contribution	£20,000	£25,000 (with tax relief)	£25,000 (with tax relief)
Inheritance tax	£8,000 (40%)	£0.00	£0.00
Beneficiary Income tax	£0.00	£0.00	£5,000 (20%)	£10,000 (40%)
Net payment	£12,000	£25,000	£20,000	£15,000

Currently pensions provide a better return than the ISA. If Joe had some nil rate band available this could reduce some or all of the IHT. 

With pensions brought into scope of IHT from 6 April 2027 Joe also needs to consider the future tax treatment of investments. 

Position from 6 April 2027

Consideration	ISA	Pension - death pre 75	Pension - death after 75
Contribution	£20,000	£25,000 (with tax relief)	£25,000 (with tax relief)
Inheritance tax	£8,000	£10,000.00	£10,000.00
Income tax	£0.00	£0.00	£3,000 (20%)	£6,000 (40%)
Net payment	£12,000	£15,000	£12,000	£9,000

With pensions exposed to IHT their returns will be reduced, especially compared to the pre-6 April 2027 position. However, where death occurs before age 75 a pension still provides a better return than an ISA on death. It also matches the ISA on death after 75 as long as payments are within the basic rate tax band.
 

Summary of differences

Issue	ISA	Pension
Eligibility	UK resident ages 18+	Anyone under 75 with UK earnings.
Maximum contributions	£20,000 a year	Unlimited, but tax relief restricted to £60,000, plus carry forward. May be restricted to £10,000 if benefits have been taken, or for high earners.
Employer funding	No	Yes – within workplace schemes.
Tax uplift on entry	No	Tax relief at marginal rate up to 100% of earnings or £3,600 if greater. No tax relief after 75.
Tax on withdrawals	Tax-free	25% tax-free, rest taxed as income at marginal rate.
IHT assessable	Yes	Not currently, but most pensions will form part of the estate from 6 April 2027.
Access restrictions	None	From age 55 (rising to 57 by 2028). Can be accessed early for those in ill health.