Lifetime ISA vs Pension – The Showdown
Rumours that the Chancellor planned to replace pensions 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 is expected to work
The LISA won’t be available until April 2017, so some details may change between now and then. However, the premise 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% penalty.
In short, a LISA is a savings vehicle with two main purposes: buying a home, and retiring.
So can a LISA replace a pension?
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.
Summing up the differences
In some respects, a LISA compares favourably with a pension. Its 25% bonus is effectively almost the same as a basic-rate taxpayer’s 20% tax relief (in that 20% tax relief on £4,000 would boost it to £5,000 – an increase of 25%, 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% 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 be another big drawback compared to a pension.
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% is certain to be tax-free. However, tax on subsequent pension income will only apply to withdrawals over the personal allowance (raised to £11,500 from April 2017).
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 would like to talk through your options for long term savings or think you could benefit from a free review of your current situation, please get in touch with the NorthStar team.
This article first appeared on Unbiased.