Pension or ISA? What the numbers say

Should I put my spare money into a pension or an ISA? It is the question I am asked most, and the one I spent longest getting straight in my own head.

The mechanics are mirror images. A pension gives you tax relief going in (the taxman tops up your contribution) and taxes you when you draw it out. An ISA is the other way round: you pay your income tax first, then whatever is left goes in and comes out completely tax-free. A financial adviser put a sharper point on it for me this week: in a pension, the growth is taxed on the way out too. In an ISA, your growth is never taxed at all.

Which makes it sound as though the ISA should win comfortably. The numbers say otherwise, most of the time. Here is a calculator so you can see exactly why, with every pound of tax shown.

Why the pension usually wins

Set both tax rates the same, say 20% in and 20% out, and the pension still comes out a few percent ahead. That feels wrong until you look at the working. Because you get relief going in, the pension invests the full, pre-tax amount, while the ISA only invests what is left after tax. The pension starts with a bigger sum, so even though its growth is taxed on the way out, it is taxing a bigger pot at the same proportional rate. The two largely cancel, and then the 25% tax-free slice tips it in the pension's favour. Tax-free growth in the ISA simply cannot catch that head start.

When your tax rate falls in retirement, which it does for a lot of people, the pension wins by a mile. Relief at 40% on the way in, tax at 20% on the way out: try it in the calculator and the gap is enormous. That is the textbook case for piling into a pension during your peak earning years.

When the ISA actually wins

There is a clear case where the ISA comes out ahead: when you will pay more tax in retirement than the relief you got going in. Put 20% in and 40% out into the calculator and the ISA pulls ahead by about 14%. The same is true if you get little or no relief now (a non-taxpayer, or someone whose pension is already large enough to push them into higher-rate tax later). When tax-later is higher than relief-now, tax-free-out beats relief-in.

It is messier than one tax rate

That calculator uses a single flat tax rate each way, which is a clean way to see the principle but not how it really works. You do not withdraw a pension all in one go. You draw it over years, and each year you get a tax-free personal allowance and a basic-rate band to fill before any higher-rate tax bites. Spread sensibly, a lot of pension income can come out at 20%, or even within the personal allowance at 0%, regardless of what you earned while working.

So your real "tax coming out" is often lower than the headline rate you would assume, which quietly strengthens the pension case again. The flip side is that the State Pension, a big drawdown, or a defined-benefit pension can stack up and push you into higher-rate tax in retirement, which is the ISA's moment. The honest version of this is a year-by-year, banded calculation, which is exactly what the main simulator does. This blog calculator is the back-of-an-envelope intuition behind it.

Beyond the tax: the bits the numbers miss

Even where the maths favours the pension, the tax is only part of the decision.

Points for the pension: if your employer matches contributions, that is free money and beats everything else on this page, do that first. You cannot touch it until pension age (currently 55, rising to 57 from 6 April 2028), which protects it from being raided. The annual allowance is generous (£60,000 for most people) versus the ISA's £20,000.

Points for the ISA: you can get at it any time, which makes it the natural way to bridge the years between stopping work and pension-access age. It is simple, the money is genuinely yours, and there is no tax to think about when you take it. From April 2027 unused pensions are due to come into inheritance tax, which shifts the estate-planning maths too.

It is not just these two

The pension-versus-ISA framing is a bit of a false choice. There is the Lifetime ISA (under-40s, a 25% government bonus toward a first home or retirement), the humble workplace pension with its match, a plain general investment account once you have filled both wrappers, and lower down the risk-and-reward ladder, premium bonds and the rest. For most people the answer is not one or the other, it is some of each, with the ISA doing the early-access job and the pension doing the long-term tax-efficient lifting.

The honest reason I lean towards a pension

If I am completely honest, there is a less mathematical reason I favour pensions, and it is the one nobody puts in a spreadsheet. I cannot trust myself with an ISA. Every time I have built one up, I have found a very good reason to raid it: a car, a kitchen, a "once in a lifetime" something. A pension I cannot touch until 55 (and 57 for younger savers from 2028) is, for me, a feature and not a bug. The lock-in saves me from myself.

So run your own numbers above, then run the proper year-by-year version in the simulator. But also be honest about which version of you is making the decision: the one with the careful plan, or the one eyeing up a new kitchen.