Pension vs ISA

From 2027, any unspent pension will be subject to IHT regardless of age at death. This has led some to argue that pensions will become no more tax-efficient than ISAs. However, when you analyse the full financial journey, how money goes in, is invested, is drawn in retirement and eventually passed on,  pensions still offer meaningful advantages, even under the new rules.

It is important to remember that pensions usually start from a larger fund than ISAs because of tax relief on the way in. If someone contributes £10,000 of net income into an ISA, £10,000 is invested. If the same £10,000 is paid into a pension, basic-rate tax relief increases the invested amount to £12,500, and for higher-rate or additional-rate taxpayers or even business owners the true cost can be even lower. This larger starting point compounds over time and remains a core reason why pensions typically grow to a higher value than ISAs,  and this advantage is unchanged by the IHT reform.

When drawing income in retirement, the pension has an advantage over the ISA. Although ISA withdrawals are fully tax-free, the pension benefits from tax relief on the way in and then allows up to 25% of the fund to be taken tax-free. The remaining 75% can be drawn down potentially within the basic-rate tax band, meaning only 20% income tax is paid. In practice, this blend of 25% tax-free cash and 75% taxed income often results in more net spendable income from a pension than from an ISA funded with the same personal cost.

Under the 2027 rules, both pensions and ISAs will face 40% IHT on death. The difference lies in what happens next. ISA proceeds are paid out with no further tax. Pension funds, however, can remain in a beneficiary drawdown arrangement. If death occurs before age 75, those beneficiaries can still withdraw the inherited pension without paying income tax. In that scenario, even after IHT, the pension still delivers more than the ISA simply because it started from a larger pot.

The real debate focuses on death after age 75. At this point, the pension is hit by IHT and any withdrawals made by beneficiaries are also taxed as income. In a basic-rate scenario, this could mean a combined tax burden of around 52% on the original pension fund. On the surface, that appears worse than the ISA, which only suffers IHT. However, this case leaves the same as the ISA fund in the scenario and only applies if the pension is left completely untouched until death, which is rarely the best strategy.

The key to preserving the pension advantage is sensible retirement planning. Most people should take their 25% tax-free cash before age 75 rather than leaving the entire fund inside the pension. Once this tax-free cash is extracted, even if it remains in the estate and is subject to IHT, it avoids the second layer of income tax that would apply if it remained inside the pension. When this simple step is factored in, pensions can still leave more to beneficiaries than ISAs, even after both IHT and income tax, and this is before considering more advanced planning such as gifting the tax-free cash or using IHT-efficient investments.

Overall Comparison – ISA vs Pension under Post-2027 Rules

(Basic-rate taxpayer, £10,000 net contribution, 5% growth over 20 years)

The conclusion is clear: pensions are no longer a “set and forget” IHT shelter, but they remain highly efficient when used actively. From 2027 onwards, the best outcomes will come from using pensions to fund retirement tax-efficiently and planning withdrawals strategically, not relying on them purely as an inheritance vehicle.