Former Chancellor George Osborne’s initiative to launch a Lifetime ISA almost two years ago has certainly divided opinion. Some believe the LISA offers a useful alternative to traditional pensions, while others argue it creates poor incentives and should be scrapped altogether. But used properly, LISAs can provide a valuable, flexible addition to traditional pension saving.
How the products stack up
|Annual subscription limit: £4,000||Annual limit for tax relief: lower of £40,000* or 100% of annual earnings**|
|Bonus: 25% (max £1,000 a year)||Bonus equivalent
(given as pension tax relief)***:
Basic-rate taxpayer: 25% (20%)
Higher-rate taxpayer: 67% (40%)****
Additional-rate taxpayer: 82% (45%)*****
|Lifetime allowance: N/A||Lifetime allowance (2018/19): £1,030,000|
|Age restrictions: must be age 18 – 39 to apply; bonuses added to subscriptions made until the saver’s 50th birthday||Age restrictions: None; must be age 55 to access your money; people aged 75 and over do not receive any bonus on contributions|
|Taking money out: Taking money out: tax-free if for a first home worth £450,000 or less; from age 60; or if you are terminally ill. Otherwise 25% penalty applied to all funds withdrawn||Taking money out (within the lifetime allowance): 25% tax free; rest taxed in the same way as income|
|Tax treatment on death: subject to IHT rules (40% tax on assets above available nil rate band)||Tax treatment on death: can usually pass on tax-free if saver dies before their 75th birthday, or at recipient’s marginal rate if after 75|
While there’s no doubt creating an extra retirement vehicle complicates the landscape for people, savvy savers can mix-and-match Lifetime ISAs and pensions to suit their needs.
The key is to ensure you know exactly what you are saving for and how much you need to set aside each month. You can then consider how a Lifetime ISA or pension, or both, could help you achieve your retirement goal.
Workplace pensions – a no-brainer
Regardless of how much you earn, you should start by making the most of the matched contributions and tax relief available through workplace pensions.
From April automatic enrolment contributions will go up to 8%. At least 3% of this will come from your employer, with you making up the difference. Your contribution comes out of your earnings before tax, so for a basic rate tax payer a reduction in take home pay of £80 gets £100 into your pension.
Making the most of this free money is a no-brainer for most savers. For the majority of people the Lifetime ISA should therefore only come into consideration for retirement savings over and above workplace pensions where there is a matched employer contribution.
Basic-rate taxpayers and the self-employed
The Lifetime ISA is potentially an attractive option for anyone paying basic-rate tax. The bonus on offer is effectively the same as in a pension up to the £4,000 limit, but Lifetime ISA funds have the flexibility to be withdrawn early (albeit with an exit penalty that means you might get back less than you put in) and completely tax free after age 60. Pensions, on the other hand, generally can’t be touched until you reach age 55 and only 25% of the fund would not be subject to income tax.
The Lifetime ISA age restriction is a bit of a pain, as is the block on bonus payments from age 50, but on a like-for-like basis the product fares well for basic-rate taxpayers. The self-employed in particular might be tempted by the combination of added flexibility and the 25% savings bonus.
Looking at the numbers, someone who pays in £4,000 a year from age 18 to 50 into either a Lifetime ISA or a SIPP, will receive exactly the same amount of Government bonus (£32,000). If we assume 4% annual investment growth after charges, both will have built a healthy looking fund worth £326,000.
Based on today’s tax rates, someone who took an ad-hoc lump sum of £20,000 from their pension at age 60 would pay £630 in tax (assuming they had no other taxable earnings). The same investor would pay no tax at all on their Lifetime ISA withdrawals.
The difference in tax paid expands as the withdrawals get bigger. If the entire fund was withdrawn at once (not an advisable retirement strategy in most cases), the pension investor would pay a whopping £95,625 in income tax.
High earners – pension first but Lifetime ISA could play a role
The way pension tax relief works means for higher and additional-rate taxpayers pensions should almost certainly be their primary retirement savings vehicle.
As well as getting 20% tax relief (equivalent to a 25% Government bonus) automatically, the same as offered by a Lifetime ISA, higher-rate taxpayers can claim an extra 20% tax relief through their tax return, while additional-rate taxpayers can claim 25%.
So if an additional-rate taxpayer paid £80 into a pension, an extra £20 would be added to it by HMRC and then they could claim back a further £25 directly from the taxman. This means it has cost them £55 to get £100 in their pension, equating to a staggering 82% savings bonus.
Wealthy savers might still be tempted to pay into a Lifetime ISA if they are bumping up against the annual or lifetime pension allowances. For those younger than 40 lucky enough to be in this position who still want to get at least some bonus on the money they save, the Lifetime ISA offers a handy savings alternative.
Tom Selby, AJ Bell Senior Analyst.
*Savers who flexibly access their pension are subject to a £4,000 annual allowance. People with income above £150,000 may have their annual allowance reduced to a minimum of £10,000
**Those without earnings can pay a maximum of £3,600 per year
***England, Wales and Northern Ireland only – Scotland adopted differential tax rates in 2018/19
****Assumes contribution is all within higher rate tax band
*****Assumes contribution is all within additional rate tax band
These articles are for information purposes only and are not a personal recommendation or advice.
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