The LIfetime ISA has launched, allowing tax-free saving with bonuses, both for a home and for retirement. It sounds similar in some ways to a pension, but what are the key differences? Find out in our direct comparison. Article by Nick Green.
Rumours thatpensions were to be replaced with a kind of ‘pension ISA’ turned out to be exaggerated. Or were they?
The Lifetime ISA (surely destined to be known as LISA) looks suspiciously like the love-child of an ISA and a pension. Available only to the under-40s, it’s clearly designed to encourage saving among the young. It’s been suggested that this age group is too focused on buying a home to give much thought to retirement income, so the LISA could be a way to let them plan both at the same time.
How a LISA works
The premise of a LISA is that for every £4 you pay in, the government adds £1. You can pay in a maximum of £4,000 a year (for a £1,000 bonus), with the bonus added at the end of the tax year. The LISA will probably be invested in a mixture of cash and equities (so it’s not quite a cash ISA and not quite a stocks & shares ISA).
You can withdraw the money (plus bonus) at any time to buy a first home (i.e. if you are not already a homeowner) and also from the age of 60. Withdrawals are expected to be possible at other times, but without the bonus and also incurring a 5 per cent penalty.
In short, a LISA is a savings vehicle with two main purposes: buying a home, and retiring.
Can you have both a LISA and a pension?
You can of course hold a LISA and a pension at the same time - indeed, this may be the best option of all. The government has been careful to point out that the LISA is not a replacement pension, but an additional product. But if a LISA can be used to save for retirement, why bother with a pension at all? This comparison table squares them up side by side so you can see why pensions are still vital things to have.
Lifetime ISA | Pension | |||
Availability | * | Only those aged under 40 can open one. | ** | Anyone over 18 can start a pension (and you can even start a pension on behalf of a child). |
Contributions | * | Maximum £4,000 a year, and forms part of your total £20,000 allowance. Maximum contribution of £128,000 | *** | Maximum £40,000 a year (tapered for those earning over £150,000). Lifetime limit of £1 million. |
Government top-up | ** | A 25% bonus at the end of each tax year, paid on deposits made before the age of 50. | *** | Tax relief on every contribution, at your marginal rate: 20% (equal to the LISA bonus), 40% or 45%. No cut-off age. |
Growth | * | Invested in a mixture of cash and equities, but likely to be lower-risk than a pension fund. | ** | Invested mostly in equities for long-term higher growth. |
Compound interest | * | Bonus added only at the year end, so misses out on compound interest throughout that year. | ** | Each contribution gets top-up instantly, so the top-up starts earning compound interest from that date. |
Tax | *** | Growth and withdrawals are both tax-free, and the bonus effectively repays basic-rate income tax. | ** | Contributions and growth are tax free. On withdrawal, 25 per cent is tax free, and the rest may be taxed depending on the rate of withdrawal. |
Flexibility | ** | Money can be withdrawn at any time, though a 25% penalty applies if not used either for a first home deposit or after the age of 60. | * | Cannot be touched until the holder is 55 or older, but after that can be freely accessed (subject to tax). |
Summing up the differences
In some respects, a LISA compares favourably with a pension. Its 25 per cent bonus is effectively almost the same as a basic-rate taxpayer’s 20 per cent tax relief (in that 20 per cent tax relief on £4,000 would boost it to £5,000 – an increase of 25 per cent, confusingly!). But there are two key differences. One is that a bonus added at the end of the year wouldn’t earn interest throughout that year – unlike the tax relief on pension contributions, which are added instantly. That would result in slightly lower growth each year for the LISA, the effects of which would multiply over time. The other, bigger difference is that higher-rate taxpayers currently receive 40 per cent tax relief on pension contributions – double the bonus given for a LISA.
The LISA also has a maximum contribution of £128,000 (before bonus) and a £4,000 annual limit that comes out of your £20,000 annual ISA allowance (available from 2017/18). By contrast, your pension has a lifetime limit of £1 million (though remember, that’s contributions plus growth) and an annual allowance of £40,000.
At present, there appear to be no plans to arrange for employer contributions into a LISA, which would beanother big drawback compared toa pension.
The verdict
Rather than a replacement pension, it looks as if the LISA is really a souped-up Help-to-Buy ISA (indeed, it will be possible to roll a Help-to-Buy ISA into a LISA). The government bonus is nearly twice as generous (because you can save into it faster) and the use has been made more flexible, so you can keep any leftover savings to help fund your retirement.
But would you want to? That is the big question. Once you’ve bought a home, the advantages of the LISA are harder to see. Yes, you can get at the cash in an emergency, but in that scenario it would be no better than a standard ISA (because you’d lose the bonus).
The main advantage of a LISA for retirement purposes is being able to withdraw all proceeds tax-free from age 60 onwards. This does go one better than a pension, where only 25 per cent is certain to be tax-free. However, tax on subsequent pension income will only apply to withdrawals over the personal allowance.
In summary? The LISA is a great new ISA, and a welcome addition to the savings toolbox. But a pension, it ain’t.
If you're interested in opening a LISA, you can compare the best cash and accounts here.
If you found this article helpful, you might also find our article on flexible ISAs informative, too.
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