Financial planning for the future is always difficult.
You don’t want to squirrel away so much that you can’t comfortably live in the present but you also want to make sure you have enough at a time when you’re no longer in a position to or no longer want to work full time.
So when you only have a limited amount of money, how do you choose between putting it into a LISA or a pension, two seemingly very similar products? And which one is better?
Pros and cons of a LISA
When the government launched the Lifetime ISA, or LISA, in 2017, it had all the designs of being a game changer.
It’s only available to those between 18 and 39, although you can pay into it until you’re 50 once you have one, and you can deposit up to £4,000 a year tax free.
It forms part of your £20,000 annual ISA allowance (so you only have a £16,000 allowance left on your regular ISA if you max out your LISA), but the government will top up your contributions with a 25% bonus.
So if you deposit the full £4,000 each year, you’d get an annual £1,000 top up until you’re 50.
And unlike a pension, you can withdraw the money any time you like. It’s penalty free to make withdrawals if you’re using the money for your first home, you’re over 60 or you’re terminally ill, with less than 12 months to live.
Otherwise you’ll be subject to a 25% penalty – it’s the government bonus plus a bit extra so you’ll get back less than what you put in.
- Access the money any time (subject to a penalty)
- Can be used to pay for a first home up to the value of £450,000
- Cash and investment options available
- Tax free saving plus tax free withdrawal when you’re 60
- 25% top up from government
- Only available to certain age groups
- You can’t pay in any more money after 50 and the top ups end too
- Capped at £4,000 a year
- Subject to inheritance tax
- Limited number of providers
- Will be taken into consideration for any Universal Credit applications
Pros and cons of a pension
You can actually have a private pension from the day you’re born although the deposits would obviously be made by your parents on your behalf.
But like other pensions, this is subject to restrictions such as when you can access the money (in your 50s) and a lifetime allowance (currently up to £1,073,100 tax free).
For the majority of the population though, there is a state pension plus the possibility of a private pension, either through work or one that you’ve applied for independently.
It’s the private pension that you’ll have the opportunity to pay additional money into instead of a LISA.
- Tax relief at your marginal income tax rate (the amount of tax you pay on the next pound you earn) until you’re 75
- You can get employer contribution
- Generally no inheritance tax implications
- Money is locked away until you’re 55
- Only 25% is tax free on withdrawal
- The remaining 75% is taxed at your marginal income tax rate
Is a LISA or a pension better?
You can have a LISA and a pension so it’s certainly not an either or scenario – this is especially true given that the maximum lifetime contribution into a LISA is £128,000, whereas the lifetime limit for a pension is £1,073,100.
So this is more about what would be a better use of your money, and the answer can depend on your income.
Thomas Skinner, financial planning director and founder of Barnaby Cecil, explained: “The LISA receives a bonus of 25% each year that you contribute, until the age of 50, whereas the pension receives tax relief at the individual’s highest marginal rate.
“Therefore, for basic rate taxpayers, the contribution made into a LISA or a pension is the same, whereas for higher or additional rate taxpayers at 40% and 45%, the rebate is more generous.
“As a result, for higher rate taxpayers, it is likely that a pension is more tax efficient than a LISA.”
But you also need to consider the tax implications of when you come to withdraw the money.
Thomas explained: “When withdrawals are made, any withdrawal from a LISA is completely tax-free, whereas from a pension, only 25% is tax-free. The remaining amount is taxed at the individual’s marginal rate.”
In other words, if you put the same amount of money in, you could potentially get more of your money back from a LISA compared to a pension when you retire so it’s certainly worth using up your allowance.
But Thomas advises against relying solely on the LISA to prepare for your retirement.
He said: “While we think that the LISA is an excellent addition to personal pensions, we do not think it will replace them due to the contribution limits.
“For higher and additional rate taxpayers, particularly those with incomes between £100,000 and £125,000, we think that the pension still remains a very important part of investment planning.”