Lifetime ISA vs a pension: what’s the difference?
The lifetime ISA (LISA) allows tax-free saving with a 25% bonus for your first home and retirement. It sounds similar to a pension, but what are the key differences? We explore what you should know.
The lifetime ISA (LISA) appears like the love-child of an individual savings account (ISA) and a pension.
Available only to those over 18 but under the age of 40, it’s designed to encourage saving among the young.
It’s been suggested this age group is too focused on buying a home to give much thought to their retirement, so a LISA could be a way to let them plan for both at the same time.
How does a lifetime ISA work?
The premise of a LISA is that for every £4 you pay in, the government adds £1. You can pay contribute a maximum of £4,000 a year (for a £1,000 bonus), with the bonus usually paid monthly.
A LISA will be invested in either cash, equities or a mixture of both. You can use the money and bonus at any time to buy your first home.
You can also withdraw money from the age of 60 or if you’re terminally ill with less than a year to live.
Withdrawals are possible at other times, but you’ll incur a 25% penalty, so this means you lose your bonus, plus lose an additional 6.25% due to the penalty.
So, the lifetime ISA penalises anyone who needs to access it early and make unauthorised withdrawals.
Can you have both a LISA and a pension?
You can 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 stress that the LISA is not a replacement pension, but an additional product.
However, if a LISA can be used to save for retirement, why bother with a pension?
This comparison table compares them side by side so you can see why a pension is still vital.
| Lifetime ISA | Pension | |
|---|---|---|
| Availability | Only those aged over 18 and under 40 can open one. | Anyone over 18 can start a pension, and you can open one on behalf of your child. |
| Contributions | Up to £4,000 a year, part of your £20,000 ISA allowance. | The lower of £60,000 a year or 100% of annual salary (tapered for those earning over £260,000). |
| Government top-up | A 25% bonus, usually paid monthly, is paid on deposits before age 50. | Tax relief on contributions at your marginal rate: 20%, 40% or 45%. |
| Growth | It can be invested in a mix of cash and equities but is likely lower risk than a pension fund. | It can be invested mostly in equities for long-term higher growth. |
| Tax | Growth and withdrawals are tax-free. | Contributions and growth are tax-free. On withdrawal, 25% is tax-free up to a limit, and the rest may be taxed depending on the withdrawal rate. |
| 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. | It cannot be touched until the holder is 55 or older, but after that, it can be accessed (subject to tax). |
| What happens when I die? | LISAs are considered part of your estate for inheritance tax (IHT) purposes, but any money, interest and bonuses are passed to beneficiaries without penalty. | If you die before 75, your pension is paid as a tax-free lump sum, subject to the lump sum and death benefit allowance. If you die after 75, it is taxed at your beneficiary’s marginal rate. |
| Does it affect means-tested benefits? | The amount you have in a lifetime ISA could impact your eligibility for means-tested benefits. | When you take money from your pension, it’ll be taken into account when determining eligibility for means-tested benefits. |
Summary
In some respects, a LISA compares favourably with a pension. Its 25% bonus is effectively 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%).
The monthly lifetime ISA bonus would earn interest, while basic tax relief on pension contributions is automatic (you may have to claim additional tax relief if you earn at least £50,271).
Higher-rate and additional-rate taxpayers currently receive 40% and 45% tax relief on pension contributions, respectively, which is a higher bonus than a LISA.
The LISA also has a maximum lifetime contribution of £128,000 (before the bonus) and a £4,000 annual limit that comes out of your £20,000 annual ISA allowance.
By contrast, your pension has an annual allowance of £60,000 or 100% of your annual salary (whichever is lower).
There appear to be no plans to arrange employer contributions into a LISA, which is a big drawback compared to a pension.
The verdict
Once you’ve bought your first home, the advantages of a LISA are harder to see.
While you can access your money in an emergency, in this scenario, it would be no better than a standard ISA (as 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 is better than a pension, where only 25% up to a specific limit is tax-free.
However, tax on subsequent pension income will only apply to withdrawals over the personal allowance.
If you found this article helpful, you might also find our article on flexible ISAs informative.
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