As the 5 April tax year-end deadline approaches many 18 to 39 year olds will be considering opening a Lifetime ISA. For those not planning to purchase a first property, the question becomes whether a LISA or a pension is a better retirement savings vehicle. The answer to that depends on your individual circumstances:
• Automatic enrolment pensions, which benefit from a matched employer contribution and tax relief, deliver a bigger bang for your retirement saving buck than LISAs
o Someone earning £30,000 who saves at the auto-enrolment minimum could have a fund worth £140,000 after 30 years*
o If the same person paid the equivalent annual personal contribution of £1,200 a year into a LISA – and received the 25% bonus each year - they could have a fund worth £87,000 after 30 years
o In other words, opting out of auto-enrolment in favour of a LISA could result in a pension worth 38% less after 30 years
• For basic-rate taxpayers saving for retirement outside their workplace pension the equation is much more marginal
o Basic-rate taxpayers who save in a LISA benefit from the same 25% upfront bonus as they would in a pension
o This would mean 30 years’ personal contributions of £1,200 a year to either a LISA or pension could generate a fund worth £87,000
o The ability to access your LISA tax-free from age 60 means that, from a purely tax perspective, it could deliver a better outcome than a pension
• However, the pendulum swings back to pensions for higher and additional-rate taxpayers saving outside their workplace pension
o A higher-rate taxpayer saving £1,200 a month into a pension could end up with a pot worth £87,000 after 30 years
o They would also have been able to reclaim £9,000 in higher-rate pension tax relief
o If that extra tax relief had been invested each year in an ISA, after 30 years it could be worth £17,000
• A pension also has a much higher annual allowance of £40,000 compared to £5,000 for Lifetime ISA (including the Government bonus) and pension savings can be passed on to loved ones tax efficiently on death
Tom Selby, senior analyst at AJ Bell, comments:
“Getting the biggest bang for your retirement buck will be one of the key considerations for people choosing where to invest their hard-earned savings.
“For those who are happy to lock up their money until later in life, it is a straight fight between LISAs and SIPPs – both of which provide an upfront savings incentive.
“The starting point for most people regardless of their tax bracket should be their workplace pension, which benefits from both a matched employer contribution and pension tax relief.
“In fact, someone earning £30,000 who contributes 8% of earnings in total – the automatic enrolment minimum – could have a fund worth £140,000 after 30 years. If the equivalent personal contribution of £1,200 a year was paid into a LISA - but without the benefit of a matched employer contribution – it could be worth £87,000 after 30 years.
“In other words, someone earning roughly the average UK salary who opted out of automatic enrolment and put their money into a LISA instead could end up with a pot worth 38% less as a result.
“However, for those who do not qualify for auto-enrolment – such as the self-employed – or for savings outside of workplace pensions the equation is more marginal and will depend in part on whether they are a basic or higher-rate taxpayer.”
LISA vs pension outside auto-enrolment – basic-rate taxpayers
“For basic-rate taxpayers saving outside auto-enrolment the LISA offers an intriguing alternative to a pension. It provides exactly the same 25% upfront savings bonus, but crucially withdrawals are tax-free from age 60.
“Pensions, on-the-the-hand, can be accessed from age 55 at the moment, with a quarter available tax-free and the rest taxed in the same way as income.
“So, where the same upfront bonus has been added each year, the key difference from an income perspective between the LISA and pension will be how withdrawals are managed in retirement.
“If taxable pension withdrawals are taken within the personal allowance it is possible the pension and LISA will deliver a similar level of income. However, if pension withdrawals are above the personal allowance and subject to income tax, it is likely the LISA will deliver more income in retirement.”
LISA vs pension outside auto-enrolment – higher-rate taxpayers
“The equation changes for higher-rate taxpayers, however, as they are able to claim extra tax relief each year.
“A higher-rate taxpayer who paid £1,200 a year into a pension could end up with a fund worth £87,000 after 30 years –the same as they could build in a LISA.
“However, crucially they could also claim back an extra 20% tax relief – or £300 a year in this example – via their pension which they would not get from their LISA. If that £300 were invested in an ISA each year, it could generate a tax-free pot worth £17,000 after 30 years.”
Thinking beyond income tax
“There are other differences between LISAs and pensions that should factor into people’s thinking when deciding which is right for their hard-earned savings.
“In most cases SIPPs benefit from a much higher annual limit of £40,000, compared to £5,000 (including the Government bonus) for LISAs.
“For those who have breached either their annual or lifetime allowance for pensions, a LISA could be a good option for any extra savings they have.
“SIPPs also benefit from generous tax treatment on death, meaning they can potentially be passed on to your nominated beneficiaries tax-free. Funds held in LISAs, on the other hand, will form part of your estate for inheritance tax purposes.
“The point at which you can access your money is also slightly different. SIPPs cannot be touched until age 55 – rising to age 57 in 2028 – while early LISA withdrawals for anything other than a first home purchase or if you become terminally ill will be hit with an early withdrawal charge by the Government. But LISAs do give you flexibility to access your fund early – albeit with a penalty - if you need to.
“Because each product has slightly different rules, strengths and weaknesses, a combination of both pensions and LISAs – and indeed traditional ISAs - might be the best approach.”
*assumes minimum auto-enrolment pension contributions are based on 100% of salary. Investment growth assumed at 4% per annum post charges in all calculations.