Ask ii: should I switch my ISA savings into my pension?

A reader asks:“I plan to retire in just under three years’ time to coincide with receiving my state pension. In terms of savings, I have around £600,000 in pensions, £210,000 in a stocks & shares ISA and £20,000 in various cash accounts. To take advantage of decent [upfront] tax relief while I’m still working, I’m wondering whether I should shift some ISA money into my SIPP over the next few years. I currently pay 40% tax and should drop down to 20% when I retire. It seems a plausible option, but I’m worried I might be missing something.”

Craig Rickman, personal finance editor at interactive investor (pictured above), says: Thanks for your question, which as you rightly note will take a bit of unpacking.

Before we dive into the weeds, it’s great to see that you’ve amassed a healthy pension and individual savings account (ISA) portfolio with retirement heaving into view.

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Due to their attractive tax advantages, these two popular accounts are great for building and managing long-term wealth. And a combination of pensions and ISAs can be a particularly savvy strategy given their contrasting structures and access rules, which can broaden your options both before and after you pack up work.

So, let’s address your question, which raises eyebrows as the common approach is to invest new money into ISAs and pensions before retirement rather than churn holdings from one tax wrapper to the other.

Although this isn’t a decision to take lightly, it can be a smart move in certain circumstances. To be clear, I can’t provide advice here; you’ll need to see a regulated financial planner for that. But I can crunch some numbers and run through the key considerations.

Consider surplus cash savings first

Before you transfer holdings between an ISA and a pension, first consider using any excess cash savings or disposable income that you’re prepared to commit for the long term. Not only can this protect the value of your ISA portfolio, providing a bigger tax-free pot to draw from down the line, but it can improve the tax-efficiency and returns of your deposit monies.

Just make sure you hold enough cash back to cover emergencies, any immediate spend, and anything else you need to meet short-term goals.

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Income tax boost?

As streamlining your income tax affairs appears your chief aim here, let’s delve into how pensions and ISAs stack up in this department.

Pensions offer income tax relief on contributions at your marginal tax rate, but withdrawals - other than the tax-free element which for most people is 25% of your total savings capped at £268,275 - are taxable. That doesn’t mean you’ll pay tax on pension income as you can still earn £12,570 a year tax free. However, this amount is largely swallowed up by the state pension, provided you’re old enough to claim and are eligible to get the full amount.

Simply put, pensions are most effective when the tax relief on the way in is greater than the tax paid on the way out. This is the key area of logic to apply when weighing up whether to move money from an ISA to a pension (but isn’t the only factor as I explain below).

With ISAs, the income tax position reverses. You don’t get upfront relief, but withdrawals are completely tax free. Both ISAs and pensions protect your investments from capital gains tax (CGT) and dividend tax, so nothing to be concerned about there.

Something to be aware of is that you can’t transfer money directly from an ISA to a pension. Instead, you need to sell the ISA holdings first, which as noted above won’t land you a tax bill, then pay the sum into your pension from your bank account. The way the tax relief works with self-invested personal pensions (SIPP), is that basic-rate relief (20%) is added straightaway, while the remaining 20% or 25% on the gross amount - depending on whether you pay higher or additional rate tax - needs to be claimed via your tax return.

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Let’s crunch some numbers to illustrate what could change if you withdrew £10,000 from a stocks & shares ISA and shifted the sum into your pension.

Due to upfront tax relief, the contribution is boosted to £12,500 automatically, and you can recover an additional £2,500 – an initial gain of £5,000.

Once you eventually withdraw the money from your pension (for simplicity’s sake we’ll ignore investment growth), £3,125 (25%) can be taken tax free, while on the rest (assuming it’s subject to basic-rate tax) you’ll receive £7,500 (£9,375 – 20%), which is £10,625 in total. If we add back in the £2,500 of reclaimed tax, you’ve essentially turned £10,000 into £13,125.

Case closed? Not quite. Let’s see what else there is to factor in.

Be sure to get higher-rate relief

Something that can trip people up is presuming that because you’re a 40% taxpayer, all pension contributions will enjoy tax relief at this rate.That’s not true; you only attract 40% relief on payments less than or equal to the earnings that fall into the higher-rate band.

Here’s an example. You earned £55,000 in 2024-25 and paid a total of £6,000 into pensions, including the basic-rate top up. During this tax year, the higher-rate threshold applied on income above £50,270, which means £4,730 of the payment was eligible for 40% relief, while £1,230 only attracted 20% relief.

This underscores that if you’re considering topping up your pension for tax planning reasons, it’s important to work out how much higher-rate relief you have available. If there’s no 40% relief, the argument for transferring money from an ISA to your pension weakens significantly.

Don’t overlook the changing tax position on death

A current appeal with pensions is that, in most cases, the leftover pot is inheritance tax (IHT) exempt on death – although if you pass away after your 75th birthday any withdrawals are taxed at the beneficiary’s marginal rate of income tax.

However, this is set to change from April 2027 when any unused pension savings on death will be brought into the IHT net. A surviving spouse or civil partner can still inherit the leftover pot tax free, and for anyone else your lifetime IHT exemptions, such as the £325,000 nil rate band, come into play. But in the absence of a stark policy U-turn, the upshot is that thousands of heirs will soon pay IHT on inherited pension assets.

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This will bring pensions in line with ISAs, which are not IHT-free either. That’s unless you’ve got the risk appetite and can stomach the volatility of investing in AIM shares. And even then, the IHT breaks will halve from April 2026.

But with pensions there’s a further catch: the potential income tax and IHT double whammy if death occurs after age 75 could see beneficiaries hit with painfully high HMRC bills. In short, anyone inheriting a pension could see a larger amount lost to IHT than if the investments remained in an ISA. This is something to bear in mind.

A lesser-known perk with ISAs is that a spouse or civil partner can inherit your ISA savings and investments and retain their tax-free status, via something called an Additional Permitted Subscription (APS).

Thinning your tax-free options down the line

One of the core attractions of retiring with investments in ISAs as well as pensions is that it widens your scope to tax-free income and capital.

For instance, let’s say you’ve maxed out your pension tax-free cash and need to fund a significant purchase which, if the full sum is funded from your pension, could push you into a higher tax bracket.

However, by retaining a sizeable ISA portfolio to dip into, you could either leave your pension untouched or keep withdrawals within the 20% band, providing added flexibility to manage your tax affairs in retirement.

Grasp pension allowances and access rules

For most people, the maximum you can pay into pensions every year and get tax relief is the lower of £60,000 or 100% of earnings. People earning more than £60,000 may be able to contribute more by tapping into unused pension allowances from previous three tax years, under something called carry forward.

Be aware that if you earn more than £200,000 a year or have already made a flexible and taxable withdrawal from your pensions, the amount you can contribute every year and get tax relief could drop to just £10,000.

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A further thing to flag is that the maximum tax-free lump sum you can draw from your pension is capped at £268,275, which is 25% of the previous lifetime allowance. So, if your pension is worth more than £1.07 million, any future funding may not accrue tax-free cash entitlement, making the contributions less tax efficient.

Finally - this is generic information rather than something for you to worry about as you’re near the state pension age - the earliest you can access most pension savings is age 55, rising to 57 in 2028. ISAs, meanwhile, are far more flexible as the money can be accessed whenever you like.

Take expert advice

As you can tell, there’s quite a lot to weigh up here. On one hand, churning money from an ISA to a pension can be a prudent strategy. But on the other, you may need to do some careful and precise calculations, understand pension contributions limits, and be mindful of any broader factors that could impact your retirement. Taking expert advice before making any decisions would be a shrewd move.