Pensions v ISAs: How to grow your investments tax-efficiently

As taxes rise in 2026/27, you no doubt want to grow your investments tax-efficiently to make the most of your gains.

From 6 April 2026, the basic and higher rates of Dividend Tax have increased by two percentage points, while some Capital Gains Tax (CGT) relief rates have also risen.

Pensions and Individual Savings Accounts (ISAs) are both tax-efficient wrappers that allow you to earn investment returns without being taxed.

Choosing whether to invest via a pension or an ISA isn’t always clear-cut. While both options offer tax-free returns, the limitations, tax applications, and access restrictions vary between the two.

Read on to weigh the pros and cons of defined contribution (DC) pensions and ISAs for long-term investing.

The government may top up your contributions to a pension or certain ISAs

Pensions

You can generally claim tax relief on pension contributions at your marginal rate of Income Tax. Tax relief is automatically applied at the basic rate of 20%, while higher- and additional-rate taxpayers may be able to claim a further 20% or 25%, respectively, via Self Assessment.

As such, boosting your pot by £1,000 would cost:

• A basic-rate taxpayer £800
• A higher-rate taxpayer £600
• An additional-rate taxpayer £550.

That said, tax relief is only available on contributions up to certain thresholds (more on this later).

If you’re paying into a workplace pension, your employer may also contribute to your pot. Plus, if you’re using a salary sacrifice scheme, you could benefit from reduced National Insurance contributions.

So, investing through a pension could give your fund an extra boost.

ISAs

When investing in an ISA, you can choose from:

• A Stocks and Shares ISA: Allows you to invest in stocks, funds, and bonds tax-efficiently.
• An Innovative Finance ISA (IFISA): Offers investments in peer-to-peer lending and debt-free securities.
• A Lifetime ISA (LISA): Enables you to invest similarly to a Stocks and Shares ISA with bonuses from the government, subject to the criteria below.

You can hold multiple ISA types if you choose.

LISA contributions up to £4,000 a year may be eligible for a 25% government bonus. However, these ISAs are subject to strict criteria:

• You must be under 40 to open an account.
• You can only pay in until age 50.
• Funds must be used to buy a first home or withdrawn after age 60.
• Early withdrawal could result in a penalty charge of 25%, removing the bonus and a portion of your contributions.

It’s worth noting that LISAs are expected to be replaced by a new type of ISA, which will only be suitable for first-time buyers, by April 2028, as Money Marketing reports.

There is no government bonus when paying into a standard Stocks and Shares ISA or IFISA.

ISAs generally have a lower tax-efficient allowance than pensions

Pensions

You can pay any amount into your pension, and the growth will be exempt from Income Tax, Dividend Tax, and Capital Gains Tax.

However, tax relief is generally only available up to the value of your annual earnings. Additionally, contributions over the Annual Allowance may be subject to a tax charge, negating the benefit of tax relief.

As of 2026/27, the Annual Allowance is £60,000. You may have a lower allowance if you’re a high earner or if you have triggered the Money Purchase Annual Allowance (MPAA) by flexibly accessing your pension. In both cases, your tax-efficient allowance could be reduced to £10,000 a year.

As such, it’s important to seek advice to ensure you understand your Annual Allowance.

ISAs

As of 2026/27, you have a tax-efficient allowance of £20,000 across all adult ISAs, including:

• Cash ISAs
• Stocks and Shares ISAs
• IFISAs
• LISAs (£4,000 annual limit)

So, you could invest up to £20,000 a year without being taxed on the returns. ISA contributions exceeding the tax-efficient allowance could be subject to CGT, Dividend Tax, and Income Tax.

It’s worth noting that the ISA allowance is set to change. From April 2027, the Cash ISA allowance will effectively reduce to £12,000 a year for under-65s, with £8,000 a year reserved for investment ISAs.

You will generally pay Income Tax when drawing down from your pension

Pensions

You can usually take up to 25% of your pension pot as a tax-free lump sum, up to the Lump Sum Allowance of £268,275 (2026/27).

For the 75% of your pension beyond the tax-free lump sum, withdrawals are typically subject to Income Tax at 20%, 40%, or 45%. The rate is determined by your level of income in retirement, including any other earnings such as your State Pension.

You may be able to mitigate your tax liability by carefully planning your retirement income.

ISAs

You typically won’t be taxed when withdrawing funds from your ISA.

As noted above, LISAs may be an exception here. If you use the money before age 60 for anything other than purchasing your first home, you could face an early withdrawal charge of 25%.

Funds may be more accessible in an ISA than in a pension

Pensions

You can’t usually access your pension pot until you reach the normal minimum pension age (NMPA). In 2026/27, the NMPA is 55, although this will rise to 57 by April 2028.

If you withdraw funds from your pension after you reach 55 but before you retire, you could lose out on valuable tax benefits. As mentioned above, flexibly accessing your pot could trigger the MPAA, reducing your tax-efficient allowance to just £10,000 a year.

As such, funds in a pension are generally out of reach until later life. You must also think carefully about accessing pensions before you retire, as you limit your ability to continue making tax-efficient contributions.

These restrictions can be advantageous, as they help ensure you keep funds set aside for retirement. But if you urgently need funds sooner, you may be unable to access them.

ISAs

If you invest through a Stocks and Shares ISA, you may be able to withdraw your money at any time.

That said, it’s important to note the value of investing for the long term. Investments held over a prolonged period typically yield higher returns than short-term investing. So, it may not be wise to withdraw your money early unless you really need to.

Balanced approach

Ultimately, pensions and ISAs each have their own pros and cons. One option isn’t unilaterally better than the other; rather, it’s about striking a balance that suits your needs and goals.

If you won’t need the funds until retirement, investing through a pension is often a good option for growing your pot tax-efficiently. Although withdrawals are subject to Income Tax, your fund may benefit from tax relief and employer contributions.

However, for medium-term goals and to supplement your pension funds, ISAs may be a suitable choice. You can invest up to £20,000 a year tax-efficiently and access your money at any time without being charged Income Tax on withdrawals.

Creating a tax-efficient investment strategy tailored to your needs and goals can be complex. By understanding your goals, assessing your financial circumstances, and modelling your future cashflow, a financial planner can help you ascertain how much you might need to access before retirement and how much to pay into your pension.

Get in touch

For support in creating a tax-efficient investment strategy to help achieve your long-term goals, speak to our financial planners. Email enquiries@jesellars.co.uk or call 01934 875 919 to find out more about how we can help you.

Please note

This article is for general information only and does not constitute advice. The information is aimed at individuals only.

All information is correct at the time of writing and is subject to change in the future.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate cashflow planning or tax planning.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.

Workplace pensions are regulated by The Pensions Regulator.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.