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Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.

Our resident expert on the merits of the two tax wrappers when it comes to building up your pot
Thursday 20 May 2021 Author: Tom Selby

I have both an index linked personal pension and an employee salary sacrifice pension which was started in 2016. I am hopefully going to finish paying my mortgage in the next two or three years and want to invest an extra £100 a month for retirement.

I am torn between using my Stocks and Shares ISA (which is not anywhere near my annual allowance even if I decide to use this for the £100) or opening a SIPP.

I am aware that the SIPP will offer the basic tax relief top up of 20% and I can take 25% tax free when I crystallise the SIPP, whereas there is no tax to pay whatsoever on any money I withdraw from a Stocks and Shares ISA.

Which would be the better option? Or would a split between the two be a good idea?


Tom Selby, AJ Bell Senior Analyst says:

Deciding whether to invest your money in a pension or an ISA will depend on a number of things including your goals and personal circumstances. While the tax impact is also important, it should be considered alongside these other key factors.

If you are willing to keep your money locked up until age 55 (57 from 2028), from a purely tax perspective a pension will usually give you a bigger bang for your buck than an ISA.

This is because pensions benefit from basic-rate tax relief upfront – extra money which can then benefit from compound growth over time. ISAs, on the other hand, are more flexible, benefitting from tax-free withdrawals at any time but offering no upfront bonus.

The income your pension generates – and how it compares to what you might get from an ISA - will depend in part on how you manage your withdrawals.


Take, for example, someone who saves £1,200 a year – equivalent to £100 a month – in a pension and an ISA. Each contribution to the pension would be topped up with basic-rate tax relief, taking the total amount invested to £1,500 a year.

If both the pension and ISA enjoy 4% annual investment growth after charges, after 30 years the pension could be worth around £87,500 while the ISA could be worth £70,000.

If the pension saver was a higher-rate taxpayer or additional-rate taxpayer, they could also have claimed extra tax relief from the taxman.

While the ISA would be accessible entirely tax-free at any time, a quarter of the pension pot (£21,875) would be available tax-free, with the rest (£65,625) taxed as income. How much they receive from this taxable portion would depend on their rate of income tax.

If we assume there is no more investment growth from the point they access their pension:

If taxable withdrawals are within the personal allowance each year and therefore taxed at 0% then they would get £87,500 of income from their pension;

– If taxable withdrawals are taxed at 20% they would get £74,375 (£21,875 tax-free cash plus £52,500 income after tax) from their pension;

– If taxable withdrawals are taxed at 40% they would get £61,250 (£21,875 + £39,375) from their pension;

– If taxable withdrawals are taxed at 45% they would get £57,969 (£21,875 + £36,094) from their pension.

Where withdrawals cut across two different tax bands the actual tax someone pays will be different to those set out above. But provided pension withdrawals are taxed at 20% or less then, from a purely tax perspective, a pension should deliver more income than an ISA.


There will, of course, be other considerations when choosing between a pension and ISA other than purely the income it could potentially generate.

Flexibility will be important for lots of investors, and on this front an ISA offers much readier access to your cash before age 55 (57 from 2028) than a pension.

The difference in tax treatment on death is also worth bearing in mind. While ISAs will form part of your estate for inheritance tax (IHT) purposes, pensions in most circumstances will not.

In fact, pensions can usually be passed on tax-free to your beneficiaries if you die before age 75, and are subject to income tax when beneficiaries come to access the money if you die after your 75th birthday.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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