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Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.

Weighing up the new savings vehicle versus pensions

The new Lifetime ISA could be a boon for basic-rate taxpayers saving for retirement, providing a flexible top-up to automatic enrolment savings.

You can save into a Lifetime ISA either for a first home or retirement. The key features include:

• Available to those aged between 18 and 40

• Contribute up to £4,000 a year and receive a 25% Government top-up (same as pension tax relief for a basic rate taxpayer)

• Continue paying in and receiving Government top-up until age 50

• Withdraw tax-free for first home purchase (below £450,000), at age 60 or if in terminal ill health

• Exit penalty of 25% of funds withdrawn in all other circumstances

• That’s up to £32,000 in free money on offer from the Government if you pay in the maximum contribution every year from age 18 to age 50.

Addressing negative comments

You may have read some negative remarks around the Lifetime ISA. Some commentators have pitted the product against workplace pensions and warning it could undermine auto-enrolment. That’s the flagship Government reform that will eventually require all companies to match your first 3% of pension contributions.

If you’re thinking of quitting your auto-enrolment pension in favour of a Lifetime ISA for your retirement saving, you might want to think again.

You effectively get a 100% boost to your money through matched contributions as well as tax relief.

How much are you saving?

Only paying in the minimum total contribution of 8% through auto-enrolment (4% from you, 3% from your employer, 1% through tax relief) may not be enough to fund a decent retirement.

Basic-rate taxpayers under 40 years old, earning less than £43,000, should consider the Lifetime ISA for any savings over and above their workplace pension.

The bonus is the same as the tax relief available through pensions, and it’s more flexible if you need to get at the money in an emergency.

However, watch out for that exit penalty – because it’s on the total funds withdrawn, it typically works out as more than the Government bonus you’ll have received.

For example, someone investing £4,000 in a Lifetime ISA 2017/18 will get £1,000 Government bonus. They then decide to withdraw the entire fund (£5,000) in May 2018 to pay for a new kitchen.

Because the 25% applies to the whole £5,000, the charge is £1,250 – the bonus plus an additional £250 penalty.

Longer term benefit

Holding the funds in the Lifetime ISA until age 60 will give you an extra tax-free element to draw on alongside the 25% tax-free cash available from your pension.

That means you can leave your pension invested for longer – potentially benefiting from extra growth – while you use your tax-free income to fund the early stages of your retirement.

For many – and particularly higher and additional rate taxpayers who get tax relief at 40% and 45%, respectfully – a pension will remain the best home for their retirement savings.

Tom Selby,
senior analyst, AJ Bell

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