are lifetime ISAs worth it for Retirement?

The Lifetime ISA is designed to help people save for their first home or retirement. With its added government bonus, should you invest in a LISA or a pension? But is a LISA worth it for retirement? In this LISA vs pension debate, we need to consider the basics of both.

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 a 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 age 60. Otherwise, the funds are locked up. Please note that age 60 is not the UK retirement age.

Since the money held in a LISA grows tax-free as taxes are not imposed on the interests and dividends, your savings goals can be realised sooner. This means that you can have the buying vs renting debate sooner.

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.

But is a LISA worth it for retirement? The name “lifetime ISA” can be a little misleading. While you might be saving for retirement, a LISA is somewhat complicated and isn’t a specific pension product. There might also be better choices, such as the best ISA. After recent pension freedoms saw exit charges reduced to 1%, the 25% charge looks like 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. Let’s take a closer look at pensions before we conduct a lifetime ISA vs pension comparison.

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 your income in a pension plan but can’t exceed £60,000 annually. However, you can’t access the money you save into a pension pot until age 55.

An employee or employer can contribute to a pension, and workplace pensions and private pensions are available. The most 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 personal or self-employed contributions relative to your income tax band.

If you are a basic rate taxpayer, tax relief is 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 equivalent to a 25% boost in your savings. The tax relief can be as high as 40% for higher-rate taxpayers.

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

If you retire at 55 or reach the age of 55, you can withdraw a quarter of your pension tax-free.  But not until you’ve reached your 55th birthday. It’s an important consideration when evaluating the LISA vs SIPP choice. After you’ve withdrawn 25% from your pension, you’ll pay income tax on the remainder, whether you decide to take an annuity, enter an income drawdown, or take lump sums. You can take money out of your pension even before 55, but only under limited circumstances.

You decide what to do with your tax-free lump sum, but it’s important not to waste it. Once it’s gone, it’s gone.

But when pondering the Lifetime ISA or pension situation, when it comes to making withdrawals, don’t forget that money in a LISA cannot be accessed for your retirement until your 60th birthday.

The age at which you can access your personal pension is rising to 57 in 2028 (but you also have the chance of deferring state pension), 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 income tax rate.

Inheritance tax

If you receive a pension as an inheritance, and you want to invest your inheritance, the good news is that there is no inheritance tax 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.

If you die before age 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 while 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?

When considering long-term savings options, individuals should compare the benefits and drawbacks of investing in a lifetime ISA vs 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. On the other hand, the advantage of a pension when considering the pension or Lifetime ISA decision is the ability to receive tax relief on your contributions, which can significantly boost your savings.

However, when considering the pension vs LISA argument, 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.

Before you start, make sure you understand all the rules around investing in a Lifetime ISA. At Moneyfarm, we advocate the benefits of long-term investing and 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. 

When considering lifetime ISA vs pension, it’s important to make the most of the schemes available to you to maximise your income throughout retirement. So you should be aware that the future of the LISA could be under threat, after the Treasury Select Committee recommended the government abolish the LISA. They did this because they say it is too complex and unpopular with savers. Although up to now the government has largely ignored the recommendation, it could change in the future.

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 providing more people with advice and changing their relationship 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 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 regular investment plans.

It can be difficult to plan for retirement in the best way for you and your family. 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.

When deciding between LISA vs pension, it’s important to consider the advantages and disadvantages of each as laid out in the SIPP vs LISA comparison below.

SIPP vs LISA Comparision Table

Considering factors like tax relief, access to funds, and potential penalties, individuals should assess whether a lifetime ISA or pension aligns better with their financial objectives and time horizon.

Is a LISA better than a pension?
It depends on your financial goal. A LISA is more like a Help-to-Buy ISA for first-time homeowners, while a private pension is geared towards retirement planning. Also, the tax relief on LISA pension contributions is less than that on a private pension. Before deciding which is best for you, you must look at the tax benefits, flexibility, compound interest, government top-up, and account availability for each investment (LISA vs pension).

What are the disadvantages of a SIPP?
Tax relief applies to only £40,000 of your contribution per annum. Currently, there is a lifetime allowance of £1,073,000 for all pensions. However, the lifetime allowance will be abolished from April 2024, but lifetime allowance charges will remain. Annual fees may also apply, and SIPPs are meant for experienced investors with high net worth. These disadvantages should be weighed when comparing SIPP vs LISA.

How many SIPPs can I open in one year?
You can have multiple SIPP accounts at the same time. There is no legal limit, but having an account you can manage is better. Also, having multiple accounts means you have to pay management fees on each account.