Making your pension and ISA allowances work for you

With tax thresholds frozen and the changes from recent Budgets, many people are seeing their tax bills likely to rise each year. Even if your finances seem to be stagnating, you may still be paying more tax.

That is why it is so important to make the most of your pension and ISA allowances. When used properly, these are still two of the best ways to protect your money from extra tax and help you keep more of what you earn.

Why are more people paying higher tax?

As each year passes, HMRC figures show that hundreds of thousands more people are becoming higher-rate taxpayers compared to a few years ago. This is not because people are getting big pay rises. Instead, it is happening because wages are going up to match inflation, but income tax thresholds are staying the same.

With the income tax threshold freeze now lasting until 2031, more people will move into higher tax bands as their salaries rise. This gradual tax increase, called fiscal drag, has a larger effect than many expect. Moving into a higher tax band does not just change the tax on your salary; it also lowers the tax-free allowances on your savings and investments. That is why careful planning matters more than ever.

The hidden impact on savings

When you become a higher-rate taxpayer, your personal savings allowance drops from £1,000 to £500. If you move into the additional rate band, you lose this allowance completely. Starting in April 2027, the tax on savings interest outside tax-efficient accounts will also go up, making it more expensive in the long run to keep cash or investments without protection.

This is why pensions and ISAs are so useful. Both let your money grow without being reduced by income tax or capital gains tax each year. Making full use of these allowances can really improve your tax situation, especially as the tax year ends.

Pensions: a powerful tax planning tool

People often see pensions just as a way to save for retirement, but they are also a great tool for managing income tax now. When you pay into a personal pension, you get tax relief at your highest tax rate. For higher or additional rate taxpayers, this can make saving much more affordable.

When you pay into a personal pension, you automatically get basic-rate tax relief. If you are a higher or additional rate taxpayer, you can claim extra relief through your tax return, which lowers your total tax bill. Pension contributions also reduce your adjusted net income. This can help you keep important allowances, like the personal allowance or tax-free childcare, which you lose if your income goes over certain limits.

The annual pension allowance is quite generous at £60,000 for most people, though it can be reduced for higher earners. Often, you can also carry forward unused allowances from the past three tax years. This means you might be able to make bigger contributions after a good year.

Pensions are meant for long-term saving, and you cannot access them until at least age 55, which will rise to 57 from April 2028. This rule can actually help by encouraging steady saving and letting your investments grow without tax. When you take money out, you can usually withdraw up to 25% tax free, and the rest is taxed as income.

ISAs: flexible and tax free

ISAs work well alongside pensions because they are tax-efficient and much more flexible. The annual ISA allowance is currently £20,000 for everyone, and if you do not use it by the end of the tax year, you lose it. That is why making regular contributions is important.

The main benefit of ISAs is how simple they are. You do not pay income tax on interest, no capital gains tax on growth, and no tax when you take money out. You can access your money whenever you need it, so ISAs are great for medium-term goals or as a flexible backup to your pension savings.

Do not forget about Junior ISAs. Each child can have up to £9,000 saved for them each year, tax free. This is a great way to build long-term savings for children or grandchildren. For families who use these allowances fully, the total tax-free savings can really add up.

Pension or ISA: which comes first?

For most people, it is not about choosing just one. Using both pensions and ISAs together often works best. Pensions are usually the most tax-efficient for long-term saving, especially for higher earners. ISAs offer flexibility and easy access, making them good for shorter-term needs or as part of a balanced plan.

Having both pensions and ISAs lets you spread your money across different types of accounts, so you have more control over when and how you take income later on. This flexibility is especially helpful in retirement, when managing your tax is as important as earning income.

Getting the balance right

Tax rules are complicated and always changing. What is right for one person might not work for someone else. A financial adviser can help you understand your options and make sure you use pensions and ISAs in the best way for your needs.

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Management plc (which is authorised and regulated by the Financial Conduct Authority) for the purpose of advising solely on the Group’s wealth management products and services, more details of which are set out on the Group’s website www.sjp.co.uk/products. The ‘St. James’s Place Partnership’ and the titles ‘Partner’ and ‘Partner Practice’ are marketing terms used to describe St. James’s Place representatives.