Lifetime ISA (LISA) vs pension

A Lifetime ISA and a pension are two different ways to save for your retirement. But which is the best option? We take a look.

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Retirement saving and pension planning

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Launched in early 2017, the Lifetime ISA (or LISA) offers a new way of saving, with the added boon of a 25% government bonus towards your first home or your retirement. But is it better to save in a LISA or a traditional pension? Let’s take a look

Why was the Lifetime ISA launched?

It’s likely that the government launched the LISA with behavioural economics in mind. That’s because young people may be more motivated to save for a first home rather than a pension that they’ll only be able to access in later life. A LISA enables the holder to save for both within a single product.

How does the Lifetime ISA work?

You can open a LISA if you’re aged 18 to 39. A LISA allows you to save up to £4,000 a year, which you can put towards your first home or retirement. Use it for either of these purposes and the government will add a 25% bonus to your cash (up to £1,000 a year). 

You can open a Cash LISA or a Stocks and Shares LISA.

You have to have the LISA open for at least a year before you qualify for any bonus. So if you’re planning to buy a home in the near future, consider opening a LISA sooner rather than later. For more information, see our article that outlines what a Lifetime ISA is and how it works.

Lifetime ISA vs Pension: Which wins? 

It’s important to note that the LISA and an ordinary pension aren’t mutually exclusive products. You can have both. However, if you can only afford to save into one, it’s worth knowing the differences between them.

The key difference is that with a pension, you save from your gross salary. That means if you’re a basic rate taxpayer, adding £50 into your pension will only cost you £40 (as you save £10 in tax). If you’re a higher rate taxpayer, the saving is even greater. £50 will effectively cost you just £30 if you submit a tax return.

This calculation isn’t as straightforward with the LISA as contributions come from your net salary. Yet if you factor in the 25% bonus, a £40 contribution will earn you £10. This is the case for basic-rate and higher-rate taxpayers – so if you’re a higher-rate taxpayer, a normal pension wins on this front.

Is a pension better than a Lifetime ISA?

Aside from tax relief advantages for higher-rate taxpayers, auto-enrolment is another key benefit of a pension over a LISA. That’s because under auto-enrolment your employer also contributes to your pension. Plus, if your employer operates a ‘salary sacrifice‘ scheme, you’ll get relief on your National Insurance contributions too.

It’s also important to know that LISA contributions can affect your entitlement to state benefits. This is because normal pension contributions are excluded from eligibility calculations, but LISA contributions are not.

For example, if you have over £16,000 in your LISA (or any other savings product) you won’t qualify for a number of means-tested benefits such as Universal Credit. However, if you have over £16,000 in your pension, but less than £16,000 in savings, you could qualify. See our article on how much you’re allowed to have in savings if you’re on benefits for more information.

Also, be mindful that LISA savings are counted as assets in bankruptcy cases, whereas pension pots usually aren’t.

When does a LISA beat a pension?

When hitting retirement, you’ll only be able to access 25% of your normal pension pot tax-free. With a LISA, you’ll have access to every penny, plus the government bonus, as soon as you hit 60.

If you’re a state worker, you may only be able to access your pension when you hit full state pension age (currently 66 years old). A LISA allows you to access your funds much earlier.

Can I access my pension or Lifetime ISA early?

You can take money out of a pension from the age of 55 (rising to 57 from 2028). At this age, you can take out up to 25% of your pot tax free.

If you want access to your pension earlier than this, you’ll have to pay hefty taxes and fees, running the risk of losing your retirement savings altogether. 

With a LISA, as well as being able to use your funds to buy your first home, you’ll also be able to access your full LISA savings – including the 25% government bonus – when you’re 60. Unless you have a terminal illness, you’ll pay a 25% penalty for an early withdrawal.

How much do I need for a comfortable retirement?

The amount you need for a comfortable retirement depends on a number of factors, including how much you plan to spend in your later years. For the full lowdown, see our article on how much you’ll need to save for retirement.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

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