MILLIONS of people saving into a pension plan may just as well not bother. They could be as well off in retirement by putting their cash into tax-free schemes such as Isas, according to research by adviser Hargreaves Lansdown.

Although most higher-rate taxpayers will earn a bigger income from a pension, many people at the basic rate could do just as well in more flexible Isas that don’t require buying an annuity.

The report is one of the first to look at the impact of cutting basic rate tax relief from 22% to 20% on pension savers.

The move in April is being triggered by a welcome cut in basic rate income tax. However, it comes with a sting in the tail as millions of savers will receive a lower rate of tax relief on contributions, one of the big incentives of saving into a pension.

With a pension, tax relief on contributions is at your highest rate. If a basic rate taxpayer contributes 78p, the government tops this up to £1. From April, they will need to contribute 80p to achieve the same result.

A 30-year-old who contributes 10% of a £30,000 salary into a pension could be £9,000 worse off by 65 as a result, according to Scottish Life.

Hargreaves’ research suggests that under the new 20% regime, many basic-rate taxpayers will find pensions are hardly worth it. A 40-year old man paying tax at the basic rate and saving £300 a month, would be £19,000 – 8.3% – better off in retirement if he saved in Isas rather than a pension. This assumes he stops working at 65, lives for a further 20 years and continues paying 20% income tax in retirement.

Pensions do not look compelling for many higher-rate taxpayers either. Those who remain in the top-tax tier in retirement will be only 1% better off if they invest in a pension than in Isas.

With Isas you don’t get tax relief when you invest, but you are not taxed if you withdraw money as income or a lump sum.

Then there is added flexibility. Isa money can be accessed at any time. Once money is paid into a pension it cannot be touched until you are 50 – rising to 55 in 2010. There are also restrictions on what you can do with pension money. Up to 25% can be withdrawn as a tax-free lump sum but the rest has to be used to buy an annuity or invested in a drawdown plan.

Analysts warn against dismissing pensions. You can only save £7,000 a year into an Isa – rising to £7,200 in April. The pension rules are much more generous.

Income from Isas can also only support you for as long as you have money invested. If you live longer than expected and run out of cash, the consequences could be catastrophic.

Although many people do not like the thought of buying an annuity with their pension it will pay an income until you die.

Bob Perkins at Origen, another adviser, said: “I don’t think it’s Isas vs pensions. They each have advantages and disadvantages.”

Changes to the rules mean it has become easier to enjoy the best of both worlds.

Until April last year, individuals were only allowed to pay a percentage of their salary into a pension, depending on age. That has been scrapped and there is more flexibility on when and how much to pay into a pension.

There are still restrictions. You can only put an amount equivalent to your salary in your pension each year, up to £225,000 this year. However, there is no limit to contributions in the year before retirement. This means you can save into Isas, retaining access to your money, and roll the money into a pension later.

If you are a basic-rate taxpayer now you will only get 22% tax relief on any pension contributions – falling to 20% from April. If you expect to move into the higher-rate tax bracket, put the money in an Isa and then move it over into a pension later – you will get 40% tax relief on it all even after next April’s changes.

Laurence Dupras, 42, a director of a management consul-tancy, is a higher rate taxpayer, contributing £25,000 a year into a pension. She uses her maximum Isa allowance each year.

Dupras, of Richmond, west London, said: “I use my pension for money that I want to put aside – it is there to provide an income when I am no longer working. My Isas give me flexibility. They provide a bucket of money to dip into if I need to.”

THE PROS AND CONS

ISAS

Pros

Isas are highly flexible: you can access the money at any time.

You do not have to buy an annuity.

Cons

You can only invest £7,000 a year (rising to £7,200 next April).

Retirement income not guaranteed – you may run out of money.

PENSIONS

Pros

Invest amount equivalent to salary each year, up to £225,000.

Up to 25% of fund can be taken tax-free on retirement.

Cons

Pension cannot be accessed until 50 (55 from 2010).