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.
What’s the difference between a Lifetime ISA and a SIPP?
What’s the difference between a Lifetime ISA and SIPP for younger people when looking at retirement?
I am maxing out my company pension up to the level they match and would like to save some extra for my retirement. I would be comfortable making the investment decisions myself and have six months’ savings for day-to-day backup.
If deciding between a Lifetime ISA/SIPP, do the different income tax bands have an effect? What are the differences when looking to drawdown later in life? Are there other considerations that should be made?
Tom Selby, AJ Bell Senior Analyst says:
Usually up to £40,000 can be paid into a SIPP and benefit from tax relief. Within this annual allowance is a limit on your personal contributions of 100% of ‘relevant earnings’ – broadly your earned and investment income.
Contributions are boosted by upfront basic-rate tax relief. This means if you pay £80 into a SIPP, it will automatically be increased to £100 through tax relief.
In addition, higher and additional-rate taxpayers can claim back an extra 20% or 25% tax relief via their tax return.
This means that for a higher-rate taxpayer a £100 SIPP contribution can come at a net cost of £60, while for an additional-rate taxpayer the net cost is just £55.
A quarter (25%) of your fund is then available tax free from age 55 (rising to age 57 from 2028), with the remaining 75% taxed in the same way as income. If you choose drawdown you can time how you take your money out of your pension fund so it’s in the most tax-efficient manner.
Lifetime ISAs, on the other hand, allow you to pay in up to £4,000 a year, with each ‘subscription’ benefitting from a 25% Government bonus (up to a maximum of £1,000). In other words, on subscriptions up to £4,000 the upfront bonus is exactly the same as basic-rate pension tax relief.
You must be aged 18-39 to open a Lifetime ISA, and once opened you can keep paying in up to £4,000 annually and receiving the 25% bonus until the day before your 50th birthday, regardless of your income tax band. You can then withdraw the money tax free if it’s being put towards a first home worth £450,000 or less, from your 60th birthday, or if you become terminally ill.
In all other circumstances the Government will levy a 20% early withdrawal charge (rising to 25% from April 2021).
Investment growth is tax-free in both SIPPs and Lifetime ISAs.
From a tax angle Lifetime ISAs represent a viable alternative to SIPPs for basic-rate taxpayers, benefitting from the same upfront bonus on the first £4,000 paid in but being able to take the whole fund tax free (albeit a few years later than a SIPP).
Lifetime ISAs also offer extra flexibility as you can access the money at any age (subject to an early withdrawal charge). For higher and additional-rate taxpayers, SIPPs mean higher tax relief. As ever, it will all depend on your personal circumstances.
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Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.