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Many higher rate taxpayers could see their savings boosted by 41% by simply moving their ISA to their pension in the run up to retirement.

It's a fact that, like for like, a pension wrapper will provide a bigger spendable pot than an ISA for most savers. This is down to the combination of tax relief on contributions and the ability to take a quarter of the fund tax free. And as an added bonus, it offers greater flexibility on passing on wealth to family members.

Access? - no problem

One of the main attractions of an ISA is that savings can accumulate tax free without there being any barriers to access should cash be needed. Indeed, many clients will see their ISA as an ‘emergency’ fund as well as future savings towards specific events. But for the over 55’s, a pension can do the same and more. According to HMRC ISA statistics, 52% of savers in stocks and shares ISAs are aged 55 or over. It begs the question....should those approaching 55 or older move their existing ISA savings into their pension?

Of course, this requires sufficient earnings, annual allowance and LTA headroom. It's certainly something worth considering over the years leading up to retirement. Carry forward and spreading contributions across tax years can help. The result could be an increased fund with more tax efficient wealth transfer options.

Crunching the numbers

Do the maths and it paints a compelling picture for moving ISA funds into pension once access is removed from the equation. Anyone benefiting from higher rate tax relief by using their funds to pay a pension contribution will always get more back, even after paying tax on the income they take from their pension.

For example, a gross pension contribution of £16,667 would actually cost a higher rate taxpayer £10,000. This can be funded from an ISA. Even if it's accessed immediately with income tax at 40% on all the pension income, the return is £11,667 (£7,500 income after tax plus £4,167 tax free cash). That’s a 16.67% boost to your client's savings by simply moving it into their pension.

Of course, most clients will not be looking to access their pension while they are still working and earning. And according to the Centre for Policy Studies, less than 1 in 7 higher rate taxpayers will continue paying higher rate tax in retirement.

If they were a basic rate tax payer when they took pension income, ignoring any investment returns, what they would get back is £14,167. This provides an extra £4,167 than they would have had in their ISA - an increase of 41.7%.

The table looks at a sample of returns where the rate of tax relief on payments in is greater or equal to the income tax on withdrawals:

And remember, these figures are based on headline rates of tax. In reality the true effective rates of income tax in retirement are likely to be much lower.

Looking at what this means in terms of an annual income, taking drawdown of 4% a year from a £1M pension pot will give £40,000, split down to £10,000 tax free cash and £30,000 taxable income. Even for someone in receipt of the full flat rate state pension of £8,060, taxable income remains well below this year’s higher rate threshold of £43,000. The overall effective rate on the combined drawdown and state pension income is 11.3%, leaving spendable income of £42,648.

The only clients who could lose out by moving funds from their ISA into a pension are those only benefiting from basic rate relief on their contributions and paying tax at higher rate or above when they access their pension fund. This could include those who use the new freedoms to withdraw all their pot in one go.

Death benefits

For some clients it may be just as important to also consider what can be passed on to family members on death.

The new ISA inheritability rules provide a surviving spouse or civil partner with an increased ISA allowance equal to the value deceased's ISA at the time of their death. This effectively allows the survivor to benefit from continued tax free investment returns on their spouse's investments. But it doesn't keep the ISA out of the survivor’s IHT net. The fund could still suffer a 40% IHT charge on the second death if total assets exceed the IHT nil rate band.

Pensions on the other hand are typically free of IHT. And it's now possible to nominate anyone to receive your pension pot and for them to carry on taking an income from it. This applies even if they are below the normal pension age of 55, allowing children or grandchildren to have immediate access.

By keeping the money within the pension wrapper, they benefit from the same tax free investment returns as an inherited ISA. But unlike the ISA, it isn't limited to spouses and civil partners but can apply to anyone the deceased wants to benefit from their pension. It also means the funds don't make their way into the beneficiary's estate for IHT. There may, however, be an income tax charge for a beneficiary drawing funds from a pension:

• Should the scheme member die before age 75, any income drawdown by the beneficiaries will be tax free.
• For deaths after age 75, income will be taxed at the beneficiary's marginal income tax rate.

Conclusion

Most people will pay income tax at lower rates in retirement than during their working lives. For these people, saving in a pension over an ISA will always produce more spendable income, like for like. This also applies to those whose tax rate doesn’t change in retirement. Factor in the new pension death benefit rules and the case for pension becomes even stronger. But with pension tax relief under constant scrutiny, the time to act might be now.