Comparing pensions and lifetime ISAs

Tony Granger looks at the differences and similarities between saving for pensions or lifetime ISAs.

Pensions and lifetime ISAs (LISAs) can be used for retirement saving. A combination of both might sometimes be considered.

Lifetime ISAs

Brought in by the government in 2017 to encourage first-time buyers, one must be between age 18 and 49 to contribute. The maximum saving is £4,000 per annum, the minimum is £1. To this is added a 25% tax-free bonus. If you save £4,000 and get another £1,000 – it’s not a bad return. Investing the maximum from age 18 could earn you £33,000 in bonuses.

As an ISA, the investment grows tax-free, and the LISA is part of your overall ISA allowance in 2019/20 of £20,000.

LISAs must be used by a first-time buyer (anywhere in the world) as a deposit for a UK residential property valued at under £450,000. If not used for a home purchase, the LISA can be used for retirement from age 60. A couple could purchase the same property using their LISAs for a deposit. You can have more than one LISA, but only one in any tax year.

Saving for retirement

The LISA can be an option to save for retirement. With a LISA, you save from net after tax income. If you save £80, the cost to you is £80. Add the 25% bonus and you have £100. With a pension, you save from gross pre-tax income. To save £100 as a basic rate taxpayer costs £80. A higher rate taxpayer can obtain another 20% back from HMRC.

LISA retirement funds can only be accessed from age 60, whereas pension funds can be accessed from age 55.

Pensions versus LISAs

If employed and in the minimum auto-enrolment pension scheme, employer contributions will beat a LISA. If the pension contribution is made through salary sacrifice, National Insurance contributions and tax reliefs apply. Higher rate taxpayers with tax relief at 40% (or additional rate of 45%) will do even better.

Pension funds are protected from bankruptcy and inheritance tax (IHT). LISA funds impact on benefit entitlement and are not protected on bankruptcy or from IHT. LISAs can give full cash access (there may be a penalty to pay), whereas pension funds are limited to 25% in tax-free cash and only after age 55 (for some schemes, state retirement age). LISAs could be more accessible earlier.

Death benefits

LISA funds are always part of your estate for IHT, whereas pension benefits are generally not, and can pass outside your estate to future generations, remaining invested in tax-efficient beneficiary drawdown. On death under age 75, with a pension fund there is no income tax to pay on benefits; over age 75, the benefits are subject to income tax at the beneficiary’s marginal income tax rate.

Lifetime ISA versus pension: Summary

	Lifetime ISA	Pension basic rate	Pension higher rate
Age to open	18-39	Age 16 or parents at birth	Age 16 or parents at birth
Maximum amount per annum	£4,000	£40,000 max. with tax relief	£40,000 max. with tax relief
State contribution	25%	25% (20% tax relief)	66% (40% tax relief)
Employer contribution	0	3%+ of salary	3%+ of salary
Bonus paid/tax relief claimed	Monthly	On contribution	25% on contribution. Balanced claimed
Access	Age 60 – penalty before, unless terminal illness	Age 55	Age 55
Tax on withdrawal	None	25% tax-free, income taxable	25% tax-free, income taxable
Inheritance tax liable	Yes	No	No

If saving for a house deposit the LISA is useful, but both LISA and pension funds should be used for retirement.

Practical tip

Consider both LISA and pension funding but do not give up pension funding for the LISA.