The Lifetime ISA (LISA), has been available since April 2017 and comes with the alluring promise of a 25 per cent bonus on top of your annual savings. But how do eligible investors choose between this product and a pension.
The following guide should help you to choose which one is right for you, or whether a combination of the two is the best step.
The LISA immediately excludes a large number of potential investors and savers. This is because only those who are under the age of 40 can open one.
This might seem unfair, but the government’s rationale is that the LISA will help younger people who are having to put pension savings on hold to save for a deposit on a first home. In theory, the LISA allows you to do both at once, since you can take cash out of it in order to buy your first property as well as once you hit 60.
The big draw of the LISA is the bonus - the government will put an extra 25 per cent in on top of your own savings every year until the age of 50, with the amount you can put in each year capped at £4,000. But if you take it out before the age of 60 at any point except to use it for your first house deposit, you’ll lose all of the growth or interest, and be charged a further 5 per cent of the total.
Pros: The LISA gives you an attractive bonus every year, and those who open one at 18 and put the maximum amount in until the age of 50 could receive a total of £32,000 in government bonuses. That’s not an insignificant amount, and is particularly attractive for those who are looking to buy a property with the cash. Your LISA allowance is in addition to your annual pension allowance, so if you are already putting £40,000 into a pension each year, you can put £4,000 extra into the LISA. Your LISA savings won’t count against your Pension Lifetime Allowance either, giving those who fear their pension savings will end up being heavily taxed above this limit another attractive option for retirement savings. Once you are retired and take the money out of your LISA, there is no further tax to pay on it, unlike with a pension. Parents or grandparents could also contribute to a LISA to help save inheritance tax, with their children being able to access the cash for a house deposit.
Cons: The LISA is quite restrictive. While there was talk of savers and investors being able to withdraw LISA cash for ‘other life events’, there has been no more detail on this, and at present you can only access the money without penalty as a first-time buyer or when you hit 60. The penalties are also quite strict. If you’re wanting to use the money to trade up from a flat to a house then this won’t be for you as the rules on using LISA money only apply to first-time buyers.
You can only put £4,000 a year into it, which is unlikely to be enough to grow a decent retirement pot, especially if you are nearer the upper limit for opening an Isa.
Thanks to new rules, pensions are more flexible than ever. You can save £40,000 a year, build a pot worth up to £1m and access the cash at 55 in a variety of ways. If you don’t spend your pension during your retirement, you can pass it onto your children.
If you are employed, employer contributions to your pension can help you to build a generous pot, and may be increased if you increase your own contributions.
Pros: Unlike a LISA, you can open a pension at any age and continue to contribute for as long as you like, with a more generous £40,000 a year limit. Pensions come with a generous tax break, worth 40 per cent if you are a higher rate taxpayer, making the top up more valuable than the LISA’s 25 per cent bonus. Pensions can be passed on outside your estate for IHT purposes, and your children could receive them tax free if you die before the age of 75 or at their own marginal tax rate if you die after this age. Unless you are self-employed, employer contributions are an extremely valuable part of retirement saving and should not be underestimated.
Cons: After taking a 25 per cent tax free lump sum, you pay tax on your pension when you take it out, although if you were in a higher tax bracket when you were earning you may find that this is relatively tax efficient. The age at which you can access your pension is likely to rise, and you cannot take the money out early to meet unexpected expenses or buy your first house.