Pension or ISA: how the tax maths actually compares

Strip the pension-or-ISA question down to tax and it becomes a round trip: what the Treasury adds on the way in, against what it takes on the way out. Both wrappers grow free of tax while the money is inside, so growth cancels out of the comparison — the whole difference is at the two ends. The pension adds relief at your marginal rate going in (FA 2004 s.192) and normally taxes 75% of what comes out (PTM063300; ITEPA 2003 s.579A): a quarter normally leaves tax-free, up to the remaining lump sum allowance (£268,275 unless protected; FA 2024 Sch 9); the ISA adds nothing and takes nothing (ITTOIA 2005 Part 6 Chapter 3).

The basic-rate round trip: 6.25%

Take £8,000 of taxed pay, and run it through each wrapper with tax at basic rate on both ends of the pension leg:

£8,500 against £8,000 — the pension returns 6.25% more from the same money, and the whole margin comes from the quarter that normally leaves tax-free, up to the remaining lump sum allowance. The algebra is compact: relief grosses £1 up to £1.25, and the exit keeps 25% plus 75% at 80%, which is 85p in the pound — 1.25 × 0.85 = 1.0625. If the withdrawal instead lands at higher rate, the exit keeps only 70p in the pound and the same round trip returns £7,000 — less than the ISA. The relief rate in against the marginal rate out decides the direction.

The higher-rate round trip

For a higher-rate taxpayer the front end is worth double. A £10,000 gross contribution attracts £2,000 of relief at source plus £2,000 more through the extension of the basic rate band (FA 2004 s.192(4)):

£8,500 from a £6,000 net outlay is roughly 41.7% more than the ISA’s £6,000 — the combination of 40% relief in, 20% tax out and the 25% element. Even if the withdrawal is taxed at 40% too, the pension leg returns £7,000 against £6,000: about 16.7% ahead, from the tax-free quarter alone. The pension vs ISA tax comparison calculator computes the round trip at your own income now and in retirement.

Salary sacrifice: the pension-side extra

The round trips above use a personal contribution, which saves income tax only. Where an employer offers salary sacrifice, the pension leg also saves National Insurance — 8% on pay between £12,570 and £50,270 and 2% above (SSCBA 1992 s.8) — and the employer’s own 15% secondary NI saving (SSCBA 1992 s.9) can be added to the contribution too. £1,000 sacrificed by a basic-rate employee costs £720 of take-home and can land £1,150 in the pension. No ISA route has an equivalent. Salary sacrifice for pensions, explained works the figures.

SSCBA 1992 s.8 and s.9 · NICs (Secondary Class 1 Contributions) Act 2025.

The side effects the round trip misses

A pension contribution reduces adjusted net income pound for pound; an ISA subscription does not. Between £100,000 and £125,140 of ANI the personal allowance is withdrawn at £1 per £2 (ITA 2007 s.35) — the 60% band, priced by the £100k tax trap calculator — and between £60,000 and £80,000 the High Income Child Benefit Charge claws back child benefit at 1% per £200 (ITEPA 2003 ss.681B–681H). A contribution that pulls ANI back through either threshold carries relief well beyond the headline rate.

The effect reverses in retirement. The taxable 75% of a pension withdrawal is income, so it counts towards the same thresholds in the year it is drawn; an ISA withdrawal never enters adjusted net income at all. The two wrappers differ not just in how much tax is paid but in which years the money is visible to the income tax system — a fact of timing the single-year round trip cannot show.

ITA 2007 s.35 and s.58 · ITEPA 2003 ss.681B–681H.

What a tax-only comparison leaves out

Pension money is normally locked until the minimum pension age: 55 now, 57 from 6 April 2028 (FA 2004 s.279). The tax-free quarter is capped by the lump sum allowance. ISAs already count for inheritance tax, and most unused pension funds and death benefits will too for deaths on or after 6 April 2027 (Finance Act 2026). Product and adviser charges differ by wrapper, and a Lifetime ISA carries a 25% charge on most withdrawals before 60.