ISA and pension alert as millions could be missing out on thousands of pounds

Millions of savers in their fifties and sixties could be short-changing themselves by thousands of pounds by continuing to favour ISAs over pensions, new analysis reveals.

Nearly 4 million people aged 55 to 64 have ISAs worth an average of just over £40,000 - but many could significantly boost their returns simply by switching how they save.

While ISAs are popular because money can be withdrawn at any time, pensions come with generous tax relief which, under current rules, can supercharge investment returns - particularly for higher-rate taxpayers.

NFU Mutual said a higher rate taxpayer could effectively collect up to 41.6% more by putting cash into a pension than an ISA.

Sean McCann, Chartered Financial Planner at the firm, said: "Unless you're about to retire, pensions can seem like a bit of a dull subject - but if you're in your fifties or older, they can offer a whole new way of thinking about investment.

"Once you reach 55 you can take money from your pension either as lump sums, income or both.

"This means they can offer an attractive alternative to ISAs if you're looking to build up funds for the future.

"Latest figures show 3.9 million people aged between 55 and 64 hold ISAs with an average value of £40,945 - but many of them could be better off topping up their pension and claiming the tax relief.

"The tax boost you get when you put money into a pension can make a huge difference to returns."

Higher rate taxpayer example

Over 55, earning £60,500 a year and with £6,000 to invest

As a 40% income taxpayer, £8,000 could be invested into a pension - HMRC would then boost with a further £2,000 giving them a fund of £10,000.

Up to an additional £2,000 can then be claimed back direct from HMRC, meaning cost to them to create a £10,000 fund would be £6,000.

If this person is a higher 40% tax payer when the money is taken out of the pension, this £6,000 investment is worth £7,000, which is a boost of 16.6%.

However, if this person is a basic rate 20% taxpayer following retirement, the £6,000 is worth £8,500 - a rise of 41.6%.

The evidence of the advantage of saving into a pension comes at a time that retirement saving rules continue to shift.

While pensions have long had an edge over ISAs when it comes to inheritance tax, this too is now under review.

Mr McCann warned: "Although currently any money left in your pensions is normally free from Inheritance Tax, this is set to change from April 2027, with unspent funds set to be included in the inheritance tax calculation, bringing them into line with the Inheritance tax treatment of ISAs.

"If you die before 75, in most cases, the benefits from pensions can be paid free of Income Tax, although there are limits if paid as a lump sum. If you die after 75 your beneficiaries will be taxed on the money paid out to them after any inheritance due has been paid.''