Pension or ISA: which is better for long-term saving?
Both pensions and ISAs have important – but different – tax benefits. But which should you choose when saving for long-term goals such as retirement?
Many people invest in an individual savings account (ISA) or a pension to reduce the amount of tax they have to pay on their investments.
But which is better for long-term goals like retirement? While pensions are specifically designed to help fund retirement, there’s no reason why you can’t use your ISA savings for the same purpose.
In this article, we explore what you need to consider, as well as the tax benefits of both options.
What are the tax benefits of pensions and ISAs?
ISAs
Annual contribution limit: You can invest up to £20,000 in ISAs each tax year.
Tax-free growth: Your ISA investments grow free of income tax, dividend tax and capital gains tax.
Tax-free withdrawals: When you withdraw money from your ISA, it is tax free.
Pensions
Tax relief on contributions: When you pay into a pension, the government tops up your contributions by 20%, boosting an £80 contribution to £100. Higher-rate and additional-rate taxpayers can claim an additional 20% or 25%, respectively, by filing a self-assessment tax return.
Annual contribution limit: You can save up to £60,000 into pensions in the 2025 to 2026 tax year1. You can get tax relief on contributions up to 100% of your annual earnings, capped at £60,000. Even if you have no earned income, you can still get tax relief on the first £2,880 you pay into a pension each tax year. Those with earned income may be able to ‘carry forward’ unused pension allowances from the previous three tax years. You need to have been a member of a registered pension scheme during that time.
Withdrawals: When you take money out of a pension, up to 25% can be taken as tax-free cash (capped at £268,275) and the rest will be taxed as income. For example, a basic-rate taxpayer (someone who earns less than £50,271 but more than the tax-free personal allowance of £12,5702) could take £10,000 from their pension, with the first £2,500 tax free and the remaining £7,500 taxed at 20%. That would equate to an effective tax rate of only 15%.
This shows the attraction of pension contributions. You get 20% tax relief on your contribution, but when you withdraw money later on you might only pay an effective 15% tax. This means you could end up with more after-tax money than you put in. However, this extra benefit only occurs while you’re taking the tax-free portion of your pension.
How ISAs and pensions compare
| ISA | Pension | |
| Tax relief on contributions | No | Yes |
| Take money out at any age | Yes | No – minimum age 55 (rising to 57 from April 2028) |
| Free of capital gains tax | Yes | Yes |
| Tax-free withdrawals | Yes | 25% can be taken as tax-free cash (capped at £268,275); the rest is taxed as income |
| Annual contribution limit | £20,000 | £60,000* |
| Subject to inheritance tax | Yes | Yes from 2027** |
Notes: Information correct as at 2025-26 tax year. *Depending on earnings. Higher earners may have a lower limit. **Unspent pensions will be subject to inheritance tax from April 2027. Read our earlier article to find out what this means for you.
Source: Vanguard
How tax relief boosts long-term savings
If you’re a higher-rate taxpayer, this tax uplift is potentially even greater. Assuming you claim your extra tax relief and add it to your pension, you’ll get 40% tax relief on your pension contributions but could pay 20% income tax on withdrawals.
Let’s take an example:
- Claire is 55, earns £80,000 and wants to save £6,000 a year until she retires at age 60.
- As a higher-rate taxpayer, Claire can claim 40% tax relief on her pension contributions. You can see the difference this tax relief makes in the image below. It shows what Claire would have in an ISA or pension after five years, assuming an annual return of 5% after fees.
Source: Vanguard calculations assuming an annual return of 5% after fees.
However, this is only part of the story. We also need to consider the impact of tax when Claire withdraws the money:
- Claire was a higher-rate taxpayer when she was saving into her pension, but is a basic-rate taxpayer when she retires as she’s earning below £50,271 and more than the tax-free personal allowance of £12,570.
- Provided Claire stays below the higher-rate tax threshold, she’ll only pay 20% income tax on her pension withdrawals, of which 25% will be tax free.
Once you take tax on withdrawals into account, the calculations look more like this:
Source: Vanguard calculations assuming an annual return of 5% after fees.
Even after accounting for tax on withdrawals, Claire is still almost £15,000 better off by investing in a pension rather than an ISA. That could make a significant difference to her spending power in retirement.
What’s right for you?
Tax isn’t the only factor to consider when deciding whether to save into an ISA or pension.
You can take money out of an ISA at any time, whereas you can’t take money out of your pension until you’re 55 (rising to 57 from April 2028). If you need your money before then, a pension may not be the best choice.
Ultimately, what’s right for you will depend on your individual circumstances, including your current and future tax position, your financial goals and when you plan to retire.
1 Your pension annual allowance might be lower than £60,000 if you have a high income or you’ve already flexibly accessed your pension pot. To work out if you have a reduced (tapered) annual allowance, see HMRC’s website.
2 2025-26 tax year.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
The eligibility to invest in either ISA or Junior ISA depends on individual circumstances and all tax rules may change in future.
Eligibility to invest in a Vanguard Personal Pension depends on your individual circumstances. Please be aware that pension and tax rules may change in the future and the value of investments can go down as well as up, so you might get back less than you invested. You cannot usually access your pension savings or make any withdrawals until the age of 55, rising to the age of 57 in 2028.
If you are not sure of the suitability or appropriateness of any investment, product or service you should consult an authorised financial adviser. Please note this may incur a charge.
Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.
Any tax reliefs referred to are those available under current legislation, which may change, and their availability and value will depend on your individual circumstances. If you have questions relating to your specific tax situation, please contact your tax adviser.
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