Making your pension and ISA allowances work for you

Why more of us are facing a higher tax bill this year

In June 2025, HMRC predicted the total number of higher rate income taxpayers would rise by 400,000; up 38.7% on 2022/23.¹  Driving this increase is a ‘perfect storm’ of above average inflation, rising prices and, most importantly, the recent extension to the freeze on tax thresholds.

Coupled with inflation running stubbornly above the 2% target, it’s more important than ever to make the most of the tax saving opportunities of pension and ISA allowances.

Why do frozen tax thresholds matter?

Although salaries have been steadily increasing, tax thresholds have not. And following the Budget, the freeze on income tax thresholds has been extended until 2031. This will pull growing numbers of people into a higher tax band if their earned income goes up. It will also net the government an additional £12 billion, according the Office for Budget Responsibility reports.²

This passive form of tax-raising is known as ‘fiscal drag.’

Crossing a tax threshold not only affects the rate of tax you pay on your income, it impacts the amount of tax you pay on your savings too. As a higher rate taxpayer, your personal savings allowance of £1,000 halves to £500. It vanishes altogether if you become an additional rate tax payer.

While the rate of tax you pay is currently the same as non-savings income, from April 2027 savings rates will increase by two percentage points to 22% for basic rate taxpayers, 42% for higher and 47% for additional rate taxpayers.

There is a silver lining, however. Maxing out your ISA or pension contributions, or indeed both, means you’ll get the full benefit of your annual tax allowances, helping to reduce your annual tax bill.  

Pension contributions – your secret weapon

Pension contributions are an excellent way to save, and a prudent extra contribution before tax year end could help you stay within your current tax band.

Tax relief is limited on your personal contributions to the higher of 100% of your earnings in the tax year or £3,600. However, this is still a great tax incentive. The real bonus is you receive tax relief at your highest rate of tax. When paying into a personal pension the scheme will claim 20% tax relief on your behalf, you can then claim the extra 20% or 25% from HMRC depending on the rate of tax you pay. This reduces the cost of the contribution overall.

Another benefit of making personal contributions into your pension is they reduce ‘adjusted net income’ – this is the amount used to determine your personal allowance and eligibility for tax-free childcare.

Contribution limits on pensions are also quite generous. The annual allowance tests contributions you make, and any your employer or third parties make for you. This currently stands at £60,000 for most people. It may be tapered for those with income in excess of £200,000, falling to a low of £10,000. 

Restrictions will also apply when you have started drawing certain types of pension income. 

In addition, unused annual allowance can usually be carried forward for up to three years, although the tax relief on personal contributions will still be restricted by earnings in that year.  

All investments held within a pension scheme grow tax free, and although you pay income tax when you need to take money out, the first 25% of the fund is usually tax free, capped at £268,275 for most. Pensions can only be accessed from age 55 (57 from April 2028) but that means you can't touch your fund, making it a great long-term savings vehicle.  

How can my ISAs help reduce my tax bill?

The current annual ISA allowance is £20,000 and this can be spread across different ISAs, including cash, stocks and shares or lifetime, if eligible. It’s a use-it-or-lose-it allowance, so you can’t carry forward unused allowances from previous years.

The real benefit of ISAs it that you don't pay tax on the cash or investments held within them, they grow entirely tax free. This means a tax saving in comparison to just holding funds outside the ISA wrapper. There is also no capital gains or income tax to pay should you need to access the funds, and no restrictions on when or how much you can access either, unlike pensions.  

Don’t forget about Junior ISAs either. You also have a Junior ISA allowance of £9,000. If you and your spouse or civil partner both maxed out your ISAs, and a Junior ISA, that could add up to £58,000 that you won’t be taxed on.

Budget 2025 - changes to come

In the Budget, the Chancellor announced proposals to restrict national insurance savings, from April 2029, for pension schemes that use salary sacrifice. This will limit the contributions that benefit from the extra NI saving to £2,000 per year. This won't impact the income tax relief available though, and doesn’t diminish the overall benefits of pension savings.

In addition, the Chancellor also announced proposals to limit the cash ISA allowance. From 2027, savers under 65 will only be able to save a maximum of £12,000 each year into a cash ISA. The remaining £8,000 ISA allowance can only go into a stocks and shares ISA. Alternatively the whole £20,000 can be invested into a stocks and shares ISA. The over 65s can choose to use their whole £20,000 in a cash ISA or split it as they see fit.

Which should I choose, pension or ISA?

The short answer is both, if you can. Each has different advantages and benefits, which allow you maximum flexibility when planning for both short- and long-term saving.

Of the two, pensions are still the most tax efficient for long-term investing. On the other hand, ISAs offer a tax efficient, simple and flexible way to save.  ISAs are also easily accessible, so you can withdraw money quickly, making them one of the most popular ways to save. in 2022/23 (the last year for which figures are available) adult ISAs accounted for £71.6 billion of savings. ²  

Holding a combination of ISAs and pensions is a key component of holistic financial planning. It gives you the greatest flexibility and control over your money, as well as maximum tax efficiency.

How your financial adviser can help you bring down your tax bill

Spreading your wealth across different types of investments can reduce your risk and gives you greater choice in later life on how you draw your retirement income. Many people work together with their financial adviser to help them decide on the right mix.

For us, financial advice is always about helping you and your family to get the most out of your life. As always, that means getting the most out of your money.

Have some questions about reducing tax by saving into ISAs or pensions? Find a financial adviser here; we’re here to help.

The value of an investment with St. James’s Place will link directly to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

An investment in a Stocks and Shares ISA will not provide the same security of capital associated with a Cash ISA. However, please bear in mind that over the long-term, inflation will erode the purchasing power of your capital.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.

Please note that Cash ISAs, and Lifetime ISAs are not available through St. James's Place.
 

Sources:

¹HMRC - accessed December 2025
²Government UK website - Date