Pros and cons of ISAs and pensions for retirement planning

  • Shunil Roy-Chaudhuri, Personal Finance and Investment Writer
  • 29 January 2024
  • 10 mins reading time

To encourage us to save, the UK government has set up two main tax-efficient options: pensions and ISAs (or Individual Savings Accounts). As we show in the table at the end of this article, these work in different ways. But combining the two could increase the flexibility of your retirement planning and help you deal with life’s uncertainties.

A pension scheme is a type of savings or investment plan to help set aside money for later life, when you may want to work less or retire. It can provide reassurance when you’re older and it offers certain tax advantages.

ISAs, often described as ‘wrappers’, can also protect investments and savings from tax, but you can draw from them at any time, not just in later life. Investments or savings held inside an ISA wrapper will be exempt from income tax, capital gains tax (CGT) and tax on dividends. Investments or savings that are not held (or ‘wrapped’) in an ISA, could be subject to tax.

Pensions offer significant up-front tax advantages, especially for higher rate taxpayers, perhaps most notably because employees can deduct pension contributions from their earnings for tax purposes. But you can’t usually access your pension savings until the age of 55 (or 57 from 6 April 2028).

In this article, we consider what are known as ‘defined contribution’ pensions. In this type of pension, you build up a pension pot based on how much is paid into the pension and how the pension investments perform.

Unlike pensions, ISA investments are not deducted from earnings for tax purposes. But they do offer you the flexibility to withdraw money at any time and, in contrast to pensions, ISA funds are not taxable when you come to draw on them. More specifically, any money you withdraw from an ISA is free from income tax, capital gains tax and dividend tax.

ISAs can then be a tax-efficient way to boost to your income in later life. And using both pensions and ISAs can allow you to access some of your money in an emergency while retaining some tax efficiency.

Annual pension contribution limits

Moreover, you can’t usually invest more than £60,000 a year in a pension. So if you have more than this to invest, then an ISA could be a great way to do so tax-efficiently during your pre-retirement period.

There are many ways to combine ISAs and pensions to fund your retirement and the arrangement that might suit your financial needs would depend on your unique circumstances. For illustrative purposes, we look at three arrangements here:

  • You could, for example, take money solely from your ISAs in the early years of your retirement and draw on your pension when the ISAs are exhausted. This could provide inheritance tax advantages, as your pension remains outside of your estate if you die before the age of 75. This approach could also allow your pension to benefit from any further potential growth, although returns are not guaranteed and pension investments can fall as well as rise in value.

  • You could perhaps decide to take annual lump sums from your pension. Of this, 25 percent could be taken as tax-free cash with the remaining 75 percent taxed as income. You could top this up with your ISA savings, which would not be subject to tax. This could help reduce your tax payments.

  • Where you don’t have sufficient cash available, you could consider withdrawing the full tax-free cash allowance from your pension (currently 25 percent). Some of this could then be used as income in your first year of retirement, while you could invest some of it in an ISA for future use. The remainder could, if appropriate, perhaps be left on deposit in the bank for a year and be used to support next year’s spending or further ISA investment.

These three examples are shown for illustrative purposes only. But they do indicate how ISAs and pensions could potentially be combined to take advantage of different tax efficiencies and meet different financial circumstances.

At Schroders Personal Wealth, one of our key principles is to have regular reviews with a financial adviser. This can help ensure your financial arrangements remain in step with your evolving financial circumstances and that you are making the best use of available tax-efficient opportunities.

How ISAs and pensions compare

Note on sources:

Technical detail in this article comes from the website (

Important information

This article is for information purposes only. It is not intended as investment advice.

Fees and charges apply.

The retirement benefits you receive from your pension plan depend on a number of factors including the value of your plan when you decide to take your benefits which isn’t guaranteed and can go down as well as up. The benefits of your plan could fall below the amount(s) paid in.

The value of investments and the income from them can fall as well as rise and are not guaranteed. The investor might not get back their initial investment.

Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.

Cash savings and investments are protected to the value of £85,000 per person per institution by the Financial Services Compensation Scheme (FSCS).

In preparing this article we have used third party sources which we believe to be true and accurate as at the date of writing but can give no assurances or warranty regarding the accuracy, currency or applicability of any of the contents in relation to specific situations and particular circumstances.

Any views expressed are our in-house views as at the time of publishing. This content may not be used, copied, quoted circulated or otherwise disclosed (in whole or in part) without prior written consent.

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