Pension or lifetime ISA?

A lifetime ISA (LISA) and pensions are both designed for retirement savings. Knowing how they compare is key to using each most effectively.

Rachel Lacey Last updated on 17 April 2021.
Pension or lifetime ISA?

Most people use a pension to save for retirement, but in 2017 the government launched an alternative in the form of the lifetime ISA (LISA).

Operating differently to other types of ISAs, the LISA offers savers generous incentives to put money away for either their first property or later life.

Here we take a look at how LISAs work and find out whether they could be a viable alternative to a pension.

What is a lifetime ISA?

Lifetime ISAs were launched to help younger savers tackle what will arguably be two of their biggest savings goals: that first step on the property ladder and retirement.

Open to all UK adults aged between 18 and 39, LISAs pay savers £1 for every £4 they save before age 50. You can pay in up to £4,000 each year, with a maximum annual bonus of £1,000.

So, if you invested the maximum £4,000 over 32 years between ages 18 and 50, you could end up with a £32,000 savings boost.

Any money paid into a LISA counts towards the overall £20,000 ISA allowance.

Money saved in a LISA can be accessed either to buy a first property, or after the age of 60. Take money out before age 60 for any other reason than getting on the property ladder (or terminal illness) and you will be hit with a 25% penalty.

As with any other ISA, any money you take out of a LISA is paid tax-free.

You can choose either a cash or stocks and shares lifetime ISA, however, cash options are limited with only a few building societies offering them.

» MORE: What are the different types of ISAs?

What is a pension?

Pensions are designed specifically for retirement saving. Your money is tied up until you are 55 (rising to 57 in 2028) but in return, there are generous incentives to save.

Not only do your savings grow tax free, but you get tax relief on contributions too. Tax relief is a rebate of the tax you pay on your income which is used to boost your pension contribution. It effectively means it costs a basic rate taxpayer £80 to invest £100, higher rate taxpayers pay just £60 to invest the same amount, while additional rate taxpayers pay £55.

Each year you can invest 100% of your income, up to a maximum of £40,000, into a pension.

When you access your pension, 25% can be taken tax free, thereafter any money you take from it will be subject to income tax rules.

Pensions and lifetime ISAs compared

Lifetime ISA Pension
Age availability 18 - 39 (but you can only contribute until age 50) 18-75
Allowance £4,000 a year 100% income, up to £40,000 a year
Incentives 25% bonus up to £1000 a year Tax relief on contributions equivalent to your rate of income tax. Employer contributions on workplace schemes
Tax Tax-free growth. Withdrawals tax free. Tax-free growth. 25% tax free lump sum, thereafter withdrawals subject to tax
Access To buy a first home, or after age 60. Penalties apply if accessed for other reasons, unless you are terminally ill From age 55 (rising to 57 in 2028)

Is a pension or a lifetime ISA best for me?

To really make the most of government incentives to save, savvy savers could have both a LISA and a pension. This approach would also give you a helpful bit of tax-free income in retirement. But if you can’t afford both, which should you go for?

For most savers a pension will make most sense. This is because in a workplace scheme you’ll get the benefit of employer contributions. Your employer won’t be able to pay money into a lifetime ISA on your behalf. A pension may also give you the potential for a bigger pot - you can carry on paying into a pension and get tax relief on your contributions until age 75, but with LISAs you can only contribute and get a bonus until age 50.

The argument in favour of pensions is stronger the more you earn too. With savings into a LISA limited to around £333 a month, you can pay much more into a pension and, if you pay the higher rate of tax, tax relief on a pension will outstrip the benefits of the 25% LISA bonus.

The argument is less clear cut if you don’t have access to a workplace pension.

If you don’t work you can still pay into a pension. Contributions are limited to £2,880 for non-taxpayers and the maximum government top-up you can get is £720 a year. With a LISA, you could get a £1,000 bonus, but that would be dependent on your investing the maximum £4,000 a year.

For self-employed workers a LISA may also be worth considering, because there won’t be the benefit of employer contributions. However, again your decision will be influenced by your earnings and tax position - if you’re a higher rate taxpayer, 45% tax relief on your pension contributions will outstrip the benefit of a 25% bonus on a lifetime ISA.

» COMPARE: Personal pension providers

WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.

Image source: Getty Images

About the author:

Rachel Lacey is freelance journalist with 20 years experience. She specialises in personal finance and retirement planning and is passionate about simplifying money matters for all. Read more

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