The Lifetime ISA (LISA), which is the first dual-purpose product aimed at both first-time buyers and retirement savers, has just celebrated its third anniversary.
The LISA has split opinion across the industry, with some arguing it is a useful alternative to traditional pensions and others warning it creates the wrong incentives and should be abandoned altogether.
But used properly, LISAs can provide a valuable, flexible addition to your retirement savings armoury. So what should you consider when choosing where to save your cash?
Workplace pensions – a no-brainer
Regardless of how much you earn, you should consider making the most of the matched contributions and tax relief available through your workplace pension.
Under auto-enrolment your first 3% of contributions will be matched by your employer – effectively a 100% bonus upfront. You will also receive tax relief of at least 20% on your personal contribution, meaning £80 paid in is increased to £100 automatically.
Making the most of this free money is a no-brainer for most savers. For the majority of people the LISA should therefore only come into consideration for retirement savings over and above workplace pensions.
Basic-rate taxpayers and the self-employed
The LISA is potentially an attractive retirement saving option for anyone paying basic-rate tax. You’ll receive the same bonus as a pension on contributions up to the £4,000 annual limit, while withdrawals are completely free of tax once you reach your 60th birthday.
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.
You can also access your LISA before age 60, although if it’s for anything other than a first home purchase worth £450,000 or less, or if you’re terminally ill, you’ll be hit with a 25% exit penalty that means you might get back less than you put in. Nonetheless, this safety valve may be attractive for those who don’t want to lock their money away completely.
The LISA age restriction is a bit annoying, as is the block on bonus payments from age 50 and the exit penalty for early withdrawals, 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 LISA 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 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 £500 in tax (assuming they had no other taxable earnings). The same investor would pay no tax at all on their LISA 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 £95,025 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 LISA, higher-rate taxpayers can claim an extra 20% 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 just £55 to get £100 in their pension, equating to a staggering 82% savings bonus.
Wealthy savers might still be tempted to pay into a LISA 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 LISA offers a handy savings alternative.
Tale of the tape: How LISAs and pensions stack up
|Annual limit||£4,000||Lower of £40,000* or 100% of annual earnings**|
|Government top up***||25% (max £1,000 a year)||1. Basic-rate taxpayer: 25% (20%)
2. Higher-rate taxpayer: 67% (40%)****
3. Additional-rate taxpayer: 82% (45%)*****
|Age restrictions||Must be age 18 – 39 to apply; bonuses added to subscriptions made until the saver’s 50th birthday||None, although people aged 75 and over do not receive any Government top up on contributions|
|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||1. 25% tax free; rest taxed in the same way as income
2. Must be age 55 to access your money
|Tax treatment on death||Subject to IHT rules (40% tax on assets above available nil rate band)||Can usually pass on tax-free if saver dies before their 75th birthday, or at recipient’s marginal rate if after 75|
*Savers who flexibly access their pension are subject to a £4,000 annual allowance. People with income above £110,000 may have their annual allowance reduced to a minimum of £10,000 by the annual allowance taper
**Those without earnings can pay a maximum of £3,600 per year
***For pensions this is 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
Latest investment articles
Fri, 29/05/2020 - 10:08
Thu, 28/05/2020 - 10:41
Thu, 28/05/2020 - 00:00
Thu, 28/05/2020 - 00:00
Thu, 28/05/2020 - 00:00