Why Pensions Are Still the Best Way to Save for the Future

The government has announced that from 2027, pensions will be included in inheritance tax (IHT). This change has left many people wondering: Are pensions still the best way to save for retirement?

For most people, the answer is yes! Pensions remain the most tax-efficient way to save for the future, even compared to other options like ISAs. They offer significant tax benefits, both while you’re saving and when you eventually withdraw the money.

Even if you’re not planning to use your pension for retirement income and instead want to pass it down to your children or loved ones, a pension is still likely to provide a bigger inheritance than other savings methods.

Pensions vs ISAs: Which One Is Better for Retirement?

ISAs and pensions are both great tax-efficient ways to save, but pensions have some key advantages.

? Both ISAs and pensions: Protect savings from income tax and capital gains tax. Therefore allowing your money to grow tax-free

? Pensions: You get tax relief when you pay into a pension (free money from the government) and you can take 25% of your pension tax-free when you withdraw it

Example

Let’s say you’re a higher-rate taxpayer (earning over ￡50,270 per year) and ignoring any growth...

• If you put ￡10,000 into an ISA, you’ll still have ￡10,000 when you withdraw it.
• If you put ￡10,000 into a pension, the government tops it up to ￡16,667 - thanks to tax relief.

Now, fast forward to retirement. Even if you’re still paying 40% tax when you take money out of your pension, you'd get;

• ￡4,167 completely tax-free (the 25% tax-free lump sum)

• ￡7,500 after tax (from the 75% that is taxable)

That’s ￡11,667 in spendable money compared to the ￡10,000 in an ISA - a 16.67% boost just because of tax efficiency!

For most people, this advantage is even bigger because they pay a lower tax rate in retirement than when they were working.

What About Inheritance Tax on Pensions?

From April 2027, pensions left to your family (excluding your spouse or civil partner) will be subject to inheritance tax, just like ISAs. This might sound like a big disadvantage, but in reality, pensions still come out ahead.

Example

Let’s say you contributed ￡10,000 to a pension, and it grew to ￡16,667 because of tax relief. If you pass away without using it:

• The pension pot would be taxed at 40% inheritance tax, leaving ￡10,000.
• If the person inheriting it is a basic-rate taxpayer (20%), they would then pay 20% tax on withdrawals, leaving them with ￡8,000 in spendable money.
• If they were a higher-rate taxpayer (40%), they’d still get ￡6,000 after tax, which is the same as an ISA after inheritance tax.

Because pensions start from a larger pot, even after both inheritance tax and income tax, they often provide a larger inheritance than an ISA.

How to Make Your Pension Even More Tax-Efficient

1?? Use Inherited Drawdown – Instead of taking the pension as a lump sum (which could trigger a big tax bill), your beneficiaries can withdraw money gradually to stay in lower tax brackets.

2?? Keep Your Pension Nominations Updated – Make sure your pension provider has the right details on who should inherit your pension. This ensures they have flexibility in how they receive it.

The Bottom Line

Some people worry that inheritance tax on pensions makes them less attractive. The truth is, the government’s tax relief on pensions makes them incredibly powerful, and even with inheritance tax, they still often outperform ISAs when passing money down to future generations.