Pension vs ISA: which one gives you £6K more every year in retirement?

With tax year-end only two weeks away, our calculations reveal the potential difference between pensions and ISAs when it comes to retirement saving and why using your pension could boost your annual retirement income by up to £6,000.

• For higher-rate taxpayersearning £60,000, using a pension over 40 years could boost your annual income in retirement by almost £6,000 each year in retirement compared to using a stocks and shares ISA over the same period
• A very high earner could end up with almost £10,000 more annual pension income after tax, compared with using an ISA for the same investments
• For basic-rate taxpayers, pensions could still provide a significant retirement income boost, with potential extra annual income of nearly £700 in retirement for someone earning £35,000
• ISAs are also a powerful tool for long-term investment, offering more flexible rules than pensions and are used by nearly half (47%) of interactive investor customers and website users as part of their retirement planning.

Pensions and ISAs are both powerful tax wrappers that protect your wealth from capital gains tax and dividend tax, but they have work in different ways and have different benefits.

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Newly released data from the interactive investor Great British Retirement Survey reveals that investors use both ISAs and pensions as part of their retirement savings: in fact, almost half (47%) of interactive investor customers and website users expect to receive income from their ISAs in retirement, compared to 63% expecting to receive income from a private pension or SIPP (data based on 4,000 interactive investor customers and website users surveyed by Opinium between May to July 2023).

Assumptions: 5% investment growth net of fees, income tax payable at basic rate on all pension income in retirement, 25% of withdrawals are tax free, retirement income based on a 4% withdrawal rate (this may not be right for everyone but is used as an illustration), excludes impact of employer contributions.

The calculations assume someone invests 5% of their income in a pension or invests the same amount, minus tax at their marginal rate into their ISA, so £100 paid into a pension is the equivalent of £80 paid into an ISA for a basic-rate taxpayer. They assume someone pays basic-rate income tax of 20% when they withdraw a pension income, compared to no tax when they withdraw funds from their ISA. The calculations are net of platform fees, which vary significantly between providers.

When it comes to boosting your retirement wealth, it’s vital to make the most of your workplace pension and any free employer contributions. Joining your workplace pension and paying in as soon as possible is the first step for building long-term wealth.

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But if you want to power up your retirement savings by paying in more than the minimum amount, should you choose a pension or ISA? Both pensions and ISAs are amazing tax-saving vehicles, and both have a part to play when it comes to retirement saving. Both will protect your wealth from capital gains tax and dividend tax, which has never been more important with slashed allowances bringing more investors into the tax net.

Golden pension tax rules are hugely powerful and give pension savings the edge when it comes to your retirement savings. The data reveals that a middle earner on £35,000 could boost their retirement income by an amazing £700 each year by using a pension rather than an ISA for their extra saving. This could be enough for an extra holiday or a few treats for the family. In contrast, a higher earner could get a life-changing extra £6,000 annual retirement income by using a pension rather than an ISA for their extra saving.

Investment compounding makes up-front tax relief extremely powerful as extra pension payments have time to snowball over time, giving your investments a powerful boost. Even though you pay income tax later on, you still end up with more because that extra tax boost has grown by far more than the tax you end up paying. In addition, you get to draw 25% tax-free from your pension pot, meaning that most people pay slightly more tax overall on ISA investing.

For higher-rate taxpayers, the benefits of pension saving are even greater as their pension contributions are boosted by an amazing 40% due to higher-rate tax relief. Someone earning £60,000 could end up with £6,000 more annual pension income in retirement, than if they used an ISA over 40 years. They get a 40% top up from pension tax relief when they pay into their pension but pay a lower 20% tax when they come to draw a pension income later on.

The benefits of ISAs

But tax is only part of the picture, and ISAs also have many powerful benefits for savers. ISAs have big advantages when it comes to flexibility as you can withdraw funds at any point, whereas you can only start withdrawing pension income once you reach 55 years old, rising to 57 in 2028. This flexibility is extremely valuable, especially for self-employed workers, who often need to keep a big cash buffer as their income is not predictable. ISAs are also great for medium-term saving goals such as home improvements or university costs, as you know you can withdraw funds when you need them, with no restrictions or extra tax to pay.

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Our customers love the flexibility and simplicity of ISAs and many use ISAs as a key part of their retirement planning. Our research also shows that our customers use both pensions and ISAs for retirement saving, with almost half (47%) expecting to receive an income from their ISAs in retirement, compared to 63% expecting to receive private pension income.