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.
| What is a LISA? | Lifetime ISA is a tax-free investment account for 18-39 year-olds, and you can use it to buy a first home or save for retirement |
| What is a pension? | A pension is a fund that provides income upon retirement, and an employee or employer can contribute to it |
| Lifetime ISA vs pension, which is better? | It depends on your goals. For example, a pension is used for long-term goals, while a LISA can be used for long-term and medium-term goals |
| Can I have a pension and a LISA? | Yes, you can have both |
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).
