Which is Better – Lifetime ISA or Pension?

Lifetime ISAs (LISAs) offer a compromise, as the money can be used for a first home or to support your retirement lifestyle. But do they offer a better alternative to paying into your pension?

Who Can Contribute?
Pensions are available to anyone who is a UK resident. You can even set up a pension for a child.

Most employees will have a workplace pension to which both they and their employer can contribute. If you aren’t in paid employment or if you own your own business, you can set up a pension yourself. There is nothing stopping you having both a workplace pension and a personal pension, for example, if you want to contribute a higher amount or diversify your investments further.

Business owners have even more flexibility as they can make contributions through their company or personally, depending on their tax position.

You can contribute to your pension, and receive full tax relief, up until age 75.

LISAs are a bit more limited. You can open a LISA if you are a UK resident aged between 18 and 39. You can then contribute to your LISA up until age 50. You can use gifted cash to make the contributions, but must pay the money in yourself. Employer contributions are not possible.

Pensions offer a great deal more flexibility over who can contribute and when.

How Much Can You Pay in?
Pension contribution limits can be one of the most confusing aspects of retirement planning, as there are multiple factors that can cap your contributions and it is not always clear which ones apply. To summarise:

• Anyone eligible can contribute up to £2,880 per year, which will be grossed up to £3,600.
• If you earn a salary or profits from a business, you can make gross personal contributions up to the level of your relevant UK earnings.
• Employer contributions are not capped by earnings, but must be deemed reasonable by the local inspector of taxes.
• Both personal and employer contributions are subject to an annual allowance of £40,000. However, if you have not used your full annual allowance in any of the last three tax years, and have been a member of a pension scheme throughout, you may be able to carry forward your unused allowances. You either need to have the relevant UK earnings to support the contribution, or make the contribution via your employer.
• Anyone earning over £240,000 will have their annual allowance reduced by £1 for every £2 earned over the threshold. This can reduce the annual allowance by up to £36,000 to just £4,000 per year.
• If you have taken flexible benefits from a pension, you will also have a reduced annual allowance of £4,000, with no option to carry forward your contributions.
• If your pension pot exceeds the lifetime allowance (currently £1,073,100) it may be taxed at up to 55% on the excess when you retire, reach age 75, or if you die beforehand.

LISAs are much simpler, although more limited in scope:

• You can contribute up to £4,000 per year.
• This is taken from your overall ISA allowance of £20,000.

While LISA contributions limits are much easier to understand, most people will be able to contribute more to their pensions.

Bonuses and Tax Benefits
Pensions offer the following tax benefits:

• Personal contributions are immediately uplifted by 20% tax relief (i.e. 25% of your net contribution). Higher and additional rate taxpayers can claim further relief through self-assessment.
• Employer contributions are an allowable business expense.
• Contributions deducted from salary can reduce your taxable earnings and save on National Insurance contributions.
• Your pension fund grows free of income tax and capital gains tax.

LISAs work as follows:

• Your contributions receive a bonus of 25%. This means that a contribution of £4,000 will be topped up by £1,000.
• Investments also grow free of tax.

In many cases, the tax position of LISAs and pensions will be similar. However, pensions have the edge for higher and additional rate taxpayers or anyone making contributions through an employer.

Investment Options
Both pensions and LISAs offer a wide range of investment options, including cash, funds and shares.

You can set up a cash LISA, which may be useful if you plan to buy a property within the next five years. Pensions can be held in cash, although this is not usually advisable due to the long investment timescale.

Both pensions and LISAs can be transferred to another provider.

As pensions have been established for longer and are offered by a wider range of providers, you will probably have more investment options with a pension than a LISA.

Taking Money Out
The minimum age at which you can take your pension is currently 55, although it is rising to 57. You can take money out of your pension in the following ways:

• 25% of your fund can be withdrawn tax-free.
• The remainder must be designated to provide an income, which will be taxable.
• You can take a regular income, withdraw lump sums, or use your fund to buy an annuity (a guaranteed income for life).

LISA funds can only be withdrawn in the following circumstances:

• To provide a deposit on a first home, providing it is worth £450,000 or less and the purchase takes place at least 12 months after you set up your LISA.
• If you are over 60.
• If you are terminally ill.

If you withdraw your LISA funds in any other circumstances, a 25% penalty will apply. This not only recovers the bonuses, but will also eat into your own savings.

What Happens if You Die?
When you die, your pension can be passed on to your beneficiaries free of Inheritance Tax. If you die after age 75, your beneficiaries will simple pay income tax on any withdrawals they take. Pensions can be a highly efficient way of passing wealth on to the next generation.

LISAs can be passed to a spouse on death via an additional permitted subscription. They cannot be passed to anyone else.

LISAs form part of your estate for IHT purposes so are not really an effective vehicle for estate planning. However, most people of LISA-funding age are not really concerned with IHT planning as this becomes more relevant later in life.

LISA or Pension – Which One Should You Choose?
Pensions offer higher contribution limits, greater tax benefits and more flexibility, so are likely to be the most effective option where your main goal is retirement planning.

However if you are saving for a first home and meet the other conditions, a LISA can help to boost your deposit. The option to withdraw the funds penalty-free at age 60 could be regarded as a contingency if your plans change rather than the primary goal.

Please don’t hesitate to contact a member of the team to find out more about your investment options.