With ongoing changes to tax rules, particularly the introduction of inheritance tax (IHT) on pension pots from 2027, many savers may be questioning whether pensions are still the most efficient way to save for retirement.
The short answer is yes, pensions remain one of the most tax-efficient ways to grow your wealth for retirement and beyond.
Even for those who won’t rely on their pension for income, it’s likely that saving into a pension will still offer greater benefits than other tax wrappers like ISAs. Let me explain why pensions continue to be a key savings tool and how they compare to alternatives like ISAs.
Pensions vs. ISAs for Retirement
Both pensions and ISAs offer tax-free growth and protect your savings from income and capital gains tax. However, there’s a crucial difference. Pensions offer tax relief on contributions and tax-free cash withdrawals, which can result in a significantly higher return.
For example, if a higher-rate taxpayer contributes £10,000 to an ISA, that £10,000 remains the same (ignoring growth). However, if they contribute £10,000 into a pension, they’ll receive 40% tax relief, turning that into £16,667. Even when taxed on withdrawal, this amount could still yield a far higher spendable return than an ISA. Most people will pay a lower tax rate in retirement, making pensions an even better choice for long-term savings.
What About Pensions at Death?
From 2027, pensions will be included in the estate for IHT purposes unless they’re passed to a spouse or civil partner. While this change might sound like a disadvantage, pensions still offer tax advantages over ISAs in most cases.
For instance, a £16,667 pension contribution (net cost £10,000 for a higher-rate taxpayer) would face IHT at 40%, leaving £10,000. If the beneficiary is a basic-rate taxpayer, they’ll pay 20% income tax on withdrawals, leaving £8,000 net. Compare this to the £10,000 in an ISA, which would be subject to 40% IHT, leaving £6,000. Even with the new IHT rules, pensions can still leave a larger inheritance.
Maximising Pensions for Wealth Transfer
For those saving into a pension primarily for wealth transfer, it’s still a valuable tool, especially for higher-rate taxpayers receiving 40% or 45% tax relief on contributions. Modern pension schemes offer options like inherited drawdown, allowing beneficiaries to manage income withdrawals and reduce their tax burden. Ensuring your death benefit nominations are up to date is vital for maximising this flexibility.
Why Pensions Remain the Best Option
Despite the IHT changes, pensions remain the most tax-efficient long-term savings vehicle for most people. Here’s why:
- Tax Relief – Contributions are boosted by tax relief at your marginal rate, making your savings go further.
- Tax-Free Growth – Investments within your pension grow free from capital gains and income tax.
- Tax-Free Lump Sum – You can withdraw up to 25% of your pension pot tax-free.
- Employer Contributions – Many workplace pensions come with employer contributions—essentially free money towards your retirement.
- Flexibility – Modern pensions offer flexible access options, allowing you to tailor your withdrawals to your needs.
Your pension is a powerful tool – let’s make it work harder for you.
Planning Ahead
If you’re wondering whether pensions are still the best savings vehicle for you, the answer depends on your individual circumstances. For most people, especially higher earners, pensions offer unparalleled tax benefits and flexibility. However, it’s essential to plan carefully and seek advice to ensure your strategy aligns with your long-term goals.
At Willow Tree Financial Services, we specialise in helping clients navigate complex financial decisions like these. Whether you’re saving for retirement or planning to pass on wealth, we’re here to help you make the most of your money.
If you’d like to discuss your options, get in touch with us today. Let’s build a plan that works for you and your family’s future.
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The value of pensions and investments and the income they produce can fall as well as rise. You may get back less than you invested.
Tax treatment varies according to individual circumstances and is subject to change.
Tax planning, Trusts, Will Writing & Estate Planning are not regulated by the Financial Conduct Authority
Will Writing is not part of the Quilter Financial Planning offering and is offered in our own right.
Quilter Financial Planning accept no responsibility for this aspect of our business.
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Willow Tree Financial Services are a Financial Adviser firm based in Polegate, East Sussex, UK. We specialise in Financial Planning, Mortgages, Investments & Pension Planning, Protection & Insurance Wills, Trusts & Estate Planning.
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Approver Quilter Financial Services limited & Quilter Mortgage Planning Limited Feb 2025
