The Lifetime ISA. How does it compare to the standard ISA and to pensions?
The Lifetime ISA (LISA) was announced in the 2016 budget to encourage you to save for your first home or for retirement. So far, it’s had a very lukewarm reception from providers and there isn’t currently a great deal of choice available. However, let’s assume that choice isn’t the issue, and you are wondering which road to go down: LISA, ISA, pension or a combination?
These three choices are what we call ‘tax wrappers’. Essentially, the underlying investments could be in exactly the same place for all three products. Therefore, the only differences between the options are: how your money is treated for tax purposes, how much you’re allowed to invest, and how you are able to access your investment – now and in the future. With regards to how much you can contribute, it is worth mentioning that anything you contribute into a LISA counts towards your annual ISA allowance (you don’t get an additional LISA allowance unfortunately).
I started writing this article thinking that I could compare the three tax wrappers easily enough. ISA’s and pensions are completely different beasts, suitable for different outcomes. They’re easy to compare. Several attempts later however, I have concluded that LISA’s just sit uncomfortably in between the two, blurring the boundaries. Perhaps this is the governments’ intention all along though; to slowly nudge pensions aside and end tax relief once and for all.
Ask yourself “What am I saving for?”
The first question you need to ask yourself is, “what am I saving for?”
1. To help purchase your first home
A LISA is a great option (providing the purchase will be less than £450,000 and you don’t own any other properties worldwide). You can invest up to £4,000 per tax year and the government will give you a 25% bonus on what you pay in at the end of each month. Essentially, you get an immediate 25% return on your investment before you’ve even bought any investment funds! Anything you don’t use on your house purchase can be accessed once you’ve reached age 60 entirely tax-free.
2. To supplement your retirement savings
Tread carefully! It gets complicated.
- Initial bonus/tax relief
Much has been made of the 25% bonus payable on contributions into a LISA, but for a basic rate tax payer, this is exactly the same as what you get when you put your own money in to a pension. And if you are a higher rate taxpayer, you are far better off initially if you invest in a pension; 40% tax relief is just too good to be ignored! There may be additional benefits as well such as recovering lost Child Benefit and your personal income tax allowance.
- The amount you can contribute
You’re limited to £4,000 a year with a LISA whereas with a pension, you can save up to £40,000 a year. Your employer can also contribute to a pension (they can’t currently contribute to a LISA).
- Withdrawing money in retirement
When it comes to retirement, taking money out of your LISA should be straightforward and there are no tax liabilities (yet!). When taking money out of your pension on the other hand, only 25% is tax-free.
- Inheriting your retirement savings
There is also the question of what happens when you die? Pensions are unique in that they can (and should) be held in trust so that your beneficiaries receive the money tax-free when you die. A LISA? Well, this would be taxed as part of your estate and so your beneficiaries may be liable to pay inheritance tax on it.
Essentially, when saving for retirement, there are advantages and disadvantages with each option.
3. Anything else
Finally, if the answer to the question is neither of the above, then you can forget about LISA’s altogether. You can only use a LISA for these two things. Use it for any other purpose before age 60, and you’ll get hit with a very punitive 25% withdrawal penalty.
If you’re not sure what you’re saving for, then an ordinary ISA keeps your options open as you can withdraw your money at any time.
The pros and cons of each tax wrapper
Here’s a list of pros and cons for each (whilst keeping it simple!):
*depending on your earnings. **rising to State Pension Age minus 10 years
In summary, LISA’s are a ‘no-brainer’ if you’re under 40 and don’t own your own home (and aspire to do so), and the purchase price will be under £450,000. Beyond that then there is a small, very confusing window in which they make sense. At least I can now see why providers have been slow to offer LISAs to investors!
This article does not constitute advice and is only based on our opinion. For tailored advice please get in touch.