Regular readers will be familiar with the idea that a pension is a tax-efficient way of saving for retirement, but if you meet the qualifying conditions, a Lifetime ISA may be quite attractive too. Many will opt to use both, but if you can only choose one, which should you choose? In this article we’ll look at how they compare, to help you decide which works best for you.
What is a pension?
A pension is long-term, tax efficient way to save money for retirement. Most investors will save for decades, and access their money only once they reach retirement. You get tax relief on the money you pay into your pension, which makes it a very efficient way to save.
Employees may be enrolled into a workplace pension, which will mean their employer contributes as well.
Typically, you won’t be able to access your pension funds until you’re 55. This will increase to 57 in 2028.
What is a lifetime ISA?
The Lifetime ISA (LISA) is designed to encourage people under forty to save, either to get on the property ladder or for retirement. It comes with the tax benefits of an ISA, but it also includes a 25% bonus paid by the Government. This means that if you save the maximum of £4,000, you could earn a bonus of £1,000.
Tax relief vs bonus
In some circumstances, the LISA compares quite well to a pension. For example, a 20% tax payer gets 20% tax relief on payments made into a pension, meaning if they pay in 80p, the government adds 20p for a total of £1. This applies up to the annual limit of £60,000.
By comparison, the LISA would give the same saver a 25% bonus, so a deposit of 80p would attract a 20p bonus, again for a total of £1. This applies up to the annual maximum of £4,000.
So, ignoring interest and investment gains, if you pay £4,000 into either a pension or a LISA, you receive a total of £5,000.
Accessing your money
The two products have different rules for the age at which you can access your money, and different penalties for accessing it early.
With a pension, your money is locked up until you are 55 (increasing to 57 in 2028). If you want to withdraw before then you face charges of up to 55% by HMRC.
With a LISA, you can only access your money for retirement from the age of 60, or you face a 25% penalty (effectively losing the bonus on any money you withdraw). You can access the money earlier without a penalty if you’re using it to buy your first home.
Tax treatment of your savings
Your savings grow free of income tax. However, you might have to pay income tax when you eventually start to withdraw. How much tax you pay depends on how much income you will derive from it in retirement as it’s calculated according to normal income tax bands. You’ll only pay tax if you withdraw more than the personal allowance and after taking your 25% tax-free lump sum.
You don’t get tax relief when you pay money into your LISA, but you won’t have to worry about paying tax when you withdraw.
A pension might be better when …
You’re a higher rate tax payer – higher rate tax payers receive 40% tax relief by saving into a pension. This isn’t available through a LISA.
You have more money to save – the most you can save into a LISA before the bonus is added is £132,000. For pension savings, the limit including contributions and growth is £60,000 a year with no theoretical lifetime limit.
You’re an employee – all employees in the UK must be auto-enrolled onto a workplace pension scheme, into which their employer must contribute. This effectively amounts to free money from your employer.
If you want to access your money earlier – You can access your pension pot from the age of 55 (57 in 2028), and from the age of 60 with a LISA.
You want to save for longer – You can’t contribute to a LISA after the age of 50, but you can continue to save into a pension.
A Lifetime ISA might work if …
You’re buying your first home – If you’re also saving to buy your first home, you might save into a LISA before you consider a pension.
You’re self-employed – with no employer to contribute to a workplace pension, a LISA may look more attractive.
If you’ve maxed out your pension – those fortunate to reach the annual limit of £60,000 in their pension may want to channel the excess into a LISA
If you might need your money early – early withdrawal penalties are lower with a LISA, so if there’s a strong possibility that you might need your money before you reach the minimum age a LISA might be a better option.
Seek specific advice
Your exact choice of savings product can be a complicated matter, and it’s important to get specific advice that takes your personal situation into account. For bespoke advice on the best way for you to save for retirement, call our trusted partners CMME on 01489 555 080 or Click here.