Should you save more than £1 million in your pension?
Carving out the optimum strategy to save for your retirement, and mitigate tax on your earnings
The removal of the Pension Lifetime Allowance (LTA) in 2023 was a significant win for high earners, allowing unrestricted pension growth without an additional tax charge. However, the landscape changed again in October 2024 when it was announced that pensions will form part of an individual’s estate for Inheritance Tax (IHT) purposes from 6 April 2027.
This raises a crucial question: should you continue maximising pension contributions beyond £1 million, or are there better alternatives? This guide explores the tax benefits and trade-offs of pensions, compared to ISAs and Offshore Bonds.
- What is the right combination of Pensions, ISAs and Offshore Bonds?
- How should your strategy be tailored, depending on your level of income?
- Could you be impacted by these decisions when funding your retirement?
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Let’s get startedTax considerations for pensions
One of the biggest advantages of pension contributions is tax relief:
- Basic rate taxpayers (20%): Receive 20% tax relief at source, on contributions up to £60,000 or 100% of relevant earnings each year.
- Higher rate taxpayers (40%): Can claim an additional 20% relief via HMRC.
- Additional rate taxpayers (45%): Can claim an additional 25% relief via HMRC.
- On earnings between £100,000 and £125,140, the effective rate of tax relief could be as high as 60% if the pension contributions restore your tapered personal allowance.
Example:
A £10,000 pension contribution effectively costs:
- £8,000 for a basic rate taxpayer.
- £6,000 for a higher rate taxpayer.
- £5,500 for an additional rate taxpayer.
While pensions benefit from tax relief on contributions, withdrawals are subject to income tax:
- 25% of withdrawals are tax-free, up to the Lump Sum Allowance (LSA) of £268,275.
- The remaining 75% is taxed at the individual’s marginal rate (20%, 40%, or 45%).
One rule of thumb is that you ought to save into a pension if, when you retire, your marginal rate of income tax is similar to or lower than when you were working. That would typically result in a strong degree of tax efficiency, given the tax-free element up to the LSA.
However, the tax efficiency of pensions is diminished once the total value of one’s pensions exceeds £1,073,100. That’s because less than 25% of the total value is available as a tax-free withdrawal – for instance, the LSA applied to a pension valued at £3 million is equivalent to only 9% rather than 25%.
For high earners, the decision to make increased pension contributions may be taken away from you.
Pension tapering regulates the amount high-earning individuals can contribute to their pensions annually while still receiving the full benefits of tax relief.
For the 2024/25 tax year, the standard annual allowance is set at £60,000. Nonetheless, those earning a higher income may see their allowance reduced to as low as £10,000, based on their total yearly income.
Individuals with a ‘threshold income’ over £200,000 and an ‘adjusted income’ over £260,000 are subject to the tapered annual allowance. The reduction in allowance halts when ‘adjusted income’ exceeds £360,000, setting the annual allowance to a minimal £10,000 for pension savings that receive the full benefit of tax relief.
Broadly, ‘Threshold Income’ includes all taxable income received in the tax year, including rental income, bonuses, dividend, and other taxable benefits. From this you deduct any personal pension contributions to personal pension scheme.
‘Adjusted income’ includes all taxable income plus any employer pension contributions and most personal contributions to an occupational pension scheme.
Individuals exceeding both a ‘threshold income’ of £200,000 and ‘adjusted income’ of £260,000 will experience a reduction in their annual allowance by £1 for every £2 exceeding £260,000 in adjusted income.
For instance, an ‘adjusted income’ of £280,000 reduces the annual allowance by £10,000, resulting in a £50,000 allowance instead of £60,000.
What are the alternatives?
A Stocks and Shares ISA (or Investment ISA) is a tax-efficient way to invest, offering potential for higher growth than a Cash ISA. Any gains or income within an ISA are free from Capital Gains Tax and Income Tax. You can invest up to £20,000 per tax year (6 April – 5 April), and if you’re married, you might consider using your spouse’s allowance to maximise tax efficiency.
While you can withdraw funds anytime, Stocks and Shares ISAs are best suited for mid- to long-term investing, helping you ride out market fluctuations. While you won’t receive tax relief on your ISA contributions like you might with a pension, the withdrawals you make are entirely tax-free.
A General Investment Account (GIA) can be a useful addition to a retirement strategy, particularly for individuals who have already maximised their pension and ISA allowances. Unlike pensions, GIAs have no contribution limits, and unlike ISAs, they don’t offer tax-free growth or withdrawals. However, they provide full flexibility: you can invest as much as you like, access your funds at any time, and choose a wide range of investments.
While investment growth and income within a GIA are subject to capital gains tax (CGT) and dividend tax, you can make use of annual allowances – like the £3,000 CGT exemption and dividend allowance (currently £500) – to manage tax efficiently. In retirement planning, a GIA can complement other wrappers by offering liquidity, investment flexibility, and tax-planning opportunities, especially when used alongside ISAs and pensions to smooth income and reduce overall tax liabilities.
An Offshore Bond is a tax-efficient investment vehicle that can be used as an alternative to or alongside a pension for retirement planning. It offers tax-deferred growth, meaning that any gains within the bond are not subject to UK tax while they remain invested. Instead, tax is only due when withdrawals are made, allowing your investments to grow more efficiently over time.
One of the key benefits of an Offshore Bond is its withdrawal flexibility. You can take up to 5% of your original investment each year, tax-deferred for 20 years, which can be particularly useful for supplementing retirement income without an immediate tax liability.
Offshore Bonds also provide estate planning advantages, as they can be structured under a trust to help mitigate Inheritance Tax. Additionally, they offer investment flexibility, giving access to a wide range of funds, including those not typically available within UK-based wrappers.
While pensions offer tax relief on contributions, they come with restrictions on access, along with the Lump Sum Allowance (LSA) and income tax on withdrawals. An Offshore Bond, by contrast, provides greater control over when and how you draw your money, making it a valuable complement to retirement planning. However, tax treatment will depend on individual circumstances and may change, so professional advice is essential.
An illustrative example – Matt, earning £170,000
Matt is a 36 year old working at a consulting firm in London, with an annual salary of £170,000. He previously decided to make £20,000 in annual pension contributions through salary sacrifice, to bring his taxable income down to £150,000.
Matt’s employer provides 5% contributions, equating to £8,500 annually. The current value of his pensions is £110,000. He realises that, with an assumed net annual growth of 5%, the value of his pension could reach £1 million after just 17 years, with his current trajectory.
Accordingly, Matt takes the decision to bring his pension contributions down to 5%. Together with his employer’s contributions, he can now expect his pension to be worth about £1,058,000 after 24 years, when he retires at the age of 60.
Matt’s taxable income has now increased from £150,000 to £162,500 a year, because he has sacrificed less to pension contributions. He therefore takes home an extra £552 each month after income tax, which he saves into a stocks & shares ISA. After 24 years, assuming the same net annual growth of 5%, his ISA is worth about £306,000, from which he can draw flexibly and entirely tax-free.
When Matt is 60 years old, he stops working, and requires around £50,000 a year to fund his retirement. 25% of his pension withdrawals are tax-free, owing to the Lump Sum Allowance – this equates to £10,000 of his total annual pension withdrawals of £40,000. A further £12,570 of his pension withdrawals each year is earned tax-free because of his personal allowance. This means that just £17,430 of his annual pension withdrawals is subject to income tax, at 20%. Finally, he takes £13,486 each year from his ISA, tax-free. He pays just £3,486 income tax each year, taking home £50,000 – equivalent to an income tax rate of only 6.5%.
Had Matt instead continued to pay only into his pension, rather than utilising his ISA allowance alongside, then he would have a pension worth around £1,640,000 by the time he retired at 60. Because of the additional tax relief Matt would have enjoyed by sacrificing his salary, he would have about £276,000 more in retirement savings – or 20% more. He could elect to spend 20% more – around £60,000. However, his tax-free withdrawals would be limited by the Lump Sum Allowance, which equates to just 16% of this total pension pot; he could therefore have taken £10,700 tax-free, plus £12,570 more without income tax because of his personal allowance; meaning his taxable income would have been £42,230; on which he would have paid £9,352 in income tax. Matt would have taken home £56,148 each year, with an income tax rate of 14%.
On paper, Matt would have been better off by £6,148 each year, if he had continued to make higher pension contributions rather than saving some of his income into his ISA; despite the diminishing effect of tax-free pension withdrawals, capped by the Lump Sum Allowance. However, this ignores the flexibility that Matt has enjoyed for 24 years, in being able to access the value of his ISA at any time, tax-free. He is also content that he has mitigated a significant amount of income tax that he would have been liable for throughout his retirement.
An illustrative example – Nicola, with £700,000 already saved
Nicola is a 48 year old working at an investment bank in London. She has been diligent in making significant pension contributions throughout her career, and has already amassed pension savings of £700,000. Nicola earns a £210,000 salary, of which she contributes £40,000 into her pension; meanwhile her employer provides 5% contributions, equating to £10,500 annually. She realises that, with an assumed net annual growth of 5%, the value of her pension could reach £1 million after just four more years, with her current trajectory.
Nicola wants to retire at 57, and accordingly, she takes the decision to bring her pension contributions down to 5%. Together with her employer’s contributions, she can now expect her pension to be worth about £1,335,000 after 9 years, when she retires at the age of 57.
Nicola’s taxable income has now increased from £170,000 to £199,500 a year, because she has sacrificed less to pension contributions. She therefore takes home an extra £1,302 each month after income tax, which she saves into a stocks & shares ISA. After 9 years, assuming the same net annual growth of 5%, her ISA is worth about £177,000, from which she can draw flexibly and entirely tax-free.
When Nicola is 57 years old, she stops working, and requires around £55,000 a year to fund her retirement. 20% of her pension withdrawals are tax-free, owing to the Lump Sum Allowance of £268,275 – this equates to £10,000 of her total annual pension withdrawals of £50,000. A further £12,570 of her pension withdrawals each year is earned tax-free because of her personal allowance. This means that just £22,430 of her annual pension withdrawals is subject to income tax, at 20%. Finally, she takes £9,486 each year from her ISA, tax-free. She pays just £4,486 income tax each year, taking home £55,000 – equivalent to an income tax rate of only 8%.
Had Nicola instead continued to pay only into her pension, rather than utilising her ISA allowance alongside, then she would have a pension worth around £1,700,000 by the time she retired at 57. Because of the additional tax relief Nicola would have enjoyed by sacrificing her salary, she would have about £188,000 more in retirement savings – or 12% more. She could elect to take 12% more – around £61,600. However, her tax-free withdrawals would be limited further by the Lump Sum Allowance, which now equates to under 16% of this total pension pot; she could therefore have taken £9,856 tax-free, plus £12,570 more without income tax because of her personal allowance; meaning her taxable income would have been £39,174; on which he would have paid £7,835 in income tax. Nicola would have taken home £53,765 each year, with an income tax rate of 15%.
Nicola is better off by £1,235 a year, due to the diminishing effect of tax-free pension withdrawals, capped by the Lump Sum Allowance. She has also benefitted from the flexibility in being able to access the value of her ISA at any time, tax-free.
Next steps
For many, pensions will still be a core part of retirement planning due to the up-front tax relief. However, the IHT changes in 2027 mean it is crucial to diversify into ISAs, Offshore Bonds, and other tax-efficient vehicles. The right approach depends on income level, retirement goals, and intergenerational wealth planning objectives.
Speak to an expert Private Wealth Adviser to assess your specific situation and develop a tailored strategy that maximises tax efficiency and protects your wealth for future generations.
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