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Lifetime ISA vs Pension: What is Best For You, a LISA or a Pension?

The Lifetime ISA is designed to help people save for their first home or retirement, but with its added government bonus, should you be investing in a LISA or a pension?

What is a lifetime ISA (LISA)?

The Lifetime ISA (LISA) wrapper works just like a stocks and shares ISA (check here how it works) – any money you put in below the yearly limit can grow tax-free for as long as it’s in there.

How does lifetime ISA work?

If you’re under the age of 50, you can opt to put up to £4,000 in your lifetime ISA each year and receive a 25% top-up from the government – that’s £1,000 if you’ve invested the full amount.

Although the LISA is more generous than the now-defunct Help to Buy ISA, it’s been controversial due to its plans to penalise savers who might need to access their cash early. The savings pot can only be used to buy a first home or for retirement from the age of 60. Otherwise, it’s locked up.

If you need to access your money for something else, you’re charged 25% of the amount you withdraw as a penalty. This means you might get less than you had initially put in if you access your money early.

While you might be saving for retirement, the complicated LISA isn’t a specific pensions product, and there might also be better choices. After recent pension freedoms saw exit charges reduce to 1%, the 25% charge looks a massive disadvantage, especially when you can usually take 25% of your pension as a tax-free lump sum at 55.

The current government contributions to pension savings are generous for higher and additional rate taxpayers.

What is a pension?

A pension is a long term investment explicitly designed for retirement. Pension savers will remain invested for decades and access their cash when they retire. You can invest 100% of an income in a pension plan, but you can’t exceed £40,000 per annum. However, you can’t access the money you save into a pension pot until age 55. 

The most commonly used pensions are private pensions such as self-invested personal pensions (SIPP). Pension schemes give tax breaks to encourage people to save.

Tax benefits of a pension

The tax benefits of investing in a personal pension are generous. When you invest in your pension, you can claim tax relief on your contributions relative to your income tax band.

You can usually get the basic rate of tax relief automatically added to your pension contributions with your pension provider, which means you only have to pay £8,000 for a £10,000 contribution. This is the same as getting £200,000 tax relief on a pension pot worth £1 million, which is the equivalent to a 25% boost in your savings.

You can claim back more through HMRC if you’re a higher or additional rate taxpayer. This adjustment is usually reflected in your tax band.  

Personal pension wrappers act a lot like ISA wrappers. Any investments you keep in here can grow protected from tax, although you may be required to pay tax on some of your pension when you withdraw it.

Tax benefits when you withdraw your pension

Once you reach the age of 55, you can withdraw a quarter of your pension tax-free.  After that, you’ll pay income tax on the remainder, whether you decide to take an annuity, enter income drawdown, or take lump sums.

You decide what to do with your tax-free lump sum, but it’s important you don’t waste it because once it’s gone, it’s gone.

The age you can access your personal pension raises to 57 in 2028, so it’s important you do what you can today to secure your financial future.

If you do not need a big lump sum, you can choose to take your tax relief through your withdrawals. As you won’t have taken your tax-free lump sum, this is known as an uncrystallised funds pension lump sum (UFPLS).

If you withdraw £10,000 from your pension, for example, £2,500 will be tax-free. The remainder will be taxed at your marginal rate of income tax.

Inheritance tax

This can be good in terms of inheritance, as no inheritance tax is charged on a pension. However, if you withdraw your tax-free lump sum, this may be counted as part of your estate, which could increase the inheritance tax bill your loved ones have to pay.

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If you die before the age of 75, your pension will be passed on completely tax-free to your beneficiaries. A lifetime allowance check will be made on uncrystallised funds. If you’re over 75 when you die, your beneficiary will be charged their marginal rate of income tax on your pension savings.

While you may be eligible for higher rate tax relief whilst you’re contributing to your pension, you may be charged just the basic tax rate in retirement, which will give your savings a little extra boost.

Can you have a LISA and a pension?

Essentially, the lifetime ISA wasn’t designed as a pension replacement; you have to wait longer to access your money, pay higher exit charges, and could get less generous tax relief.

However, the two can be used together as a part of reliable financial planning. If you’re a higher or additional rate taxpayer and you’ve exhausted your annual pension allowance, investing in a LISA could help boost your retirement income more than in a stocks and shares ISA alone, thanks to the government bonus.

Make sure you understand all the rules around investing in a Lifetime ISA before you start. At Moneyfarm, we advocate the benefits of long-term investing, and we don’t want to penalise those who need to access their money early. However, knowing your investments balance risk and return is one thing; knowing you’ll get less than you put in if you’re forced to use it early is quite another.

Remember your annual ISA allowance is £20,000. So, if you do invest the full £4,000 in a LISA, you will still have the capacity to invest in a stocks and shares ISA afterwards.

The future of the LISA could be under threat, however, after the Treasury Select Committee recommended the government abolish the LISA, saying it is too complex and not popular with savers.

The government has largely ignored the recommendation, but it’s important to make the most of the schemes available to you to maximise your income throughout retirement.

Moneyfarm Pension

The Moneyfarm Pension is a personal pension plan designed to give you financial security throughout retirement.

As one of the first robo advisors to offer regulated investment advice, we’re committed to bringing advice to more people and changing the relationship people have with their investments.

We provide a unique combination of investment advice and discretionary management to help people grow their wealth over time.

Our free Pension Drawdown and Pension Transfer Services help you make confident, stress-free decisions to stay in control of your retirement income.

You can use Moneyfarm’s widget to help you work out how much you need to be saving a month to get the income you want in retirement or start one of Moneyfarm’s regular investment plans.

Making sure you plan for retirement in the best way for you and your family can be difficult. If you need any help, talk to an independent financial adviser and be sure to read our pension guide and our detailed guide on pension fees.

SIPP Pension vs LISAs FAQs

Eligibility

SIPP Pension: You can open a SIPP Pension account from age 18 to age 75. 
LISA: A lifetime ISA account is open to all UK adults from age 18 to 39, and contributions stop at age 50.

Contributions

SIPP Pension: 100% of an income, up to £40,000 per year
LISA: £4,000 per year 

Tax Relief

SIPP Pension: 20% – 45% tax relief on pension contributions for UK residents.
LISA: 25% bonus up to a maximum annual bonus of £1,000.

Tax Incentives

SIPP Pension: 25% tax-free lump sum withdrawal.
LISA: No income tax, capital gains tax and dividend tax. Free withdrawals.

Access to money

SIPP Pension: Access granted at the age of 55. Any withdrawals made before age 55 will come with a 55% penalty fee from HMRC.
LISA: Access granted at the age of 60. Withdrawals before age 60 have a 25% penalty. The penalty is waived if you are buying your first home or are terminally ill.

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