The introduction of the lifetime ISA (LISA) from April 2017 gives the under 40s more options when planning for retirement. Deciding between a traditional pension, ISAs and the new LISA may not be an easy choice. An understanding of how each investment works and a long term view of your retirement objectives will be essential in reaching a decision.
How does the new LISA work?
The LISA is a long-term flexible savings account which receives a bonus from the Government provided the savings are used to either help buy a first home worth up to £450,000, or for retirement. Up to £4,000 can be saved each year until the age of 50 and the Government will contribute a further 25 per cent on top of this. This bonus is the equivalent of the basic rate tax relief received on a personal pension contribution. However there is no further relief for higher or additional rate taxpayers, as there would be with traditional pension savings.
Although you have the flexibility of withdrawing funds before retirement withdrawals before the age of 60 (which are not used to purchase a first home) will be at a cost. They will suffer a 5 per cent charge and the bonus received, together with any compound interest on the bonus, will also need to be repaid.
How does this compare to traditional pension savings?
A big advantage of the traditional pension is the ability to cascade the fund down to the next generation without suffering any inheritance tax (IHT). In contrast funds invested in LISAs and ISAs will be part of the individual’s estate at death for IHT purposes potentially creating a 40 per cent tax liability on the fund.
If comparing a workplace pension to a LISA you will need to consider employer contributions. If a workplace pension is available to you it will generally represent the best retirement saving option.
Recent changes to pensions, together with alternative planning options were talked about in detail in August 2015 tax voice article 'Pension changes – what are the options?' and in the January 2015 'Pensions: after 6 April' article.
There are good reasons to use a LISA, but with a lower overall possible lifetime fund, no employer contributions, no IHT advantages, no further tax relief for higher or additional rate taxpayers, and a five year further wait to withdraw funds in retirement the new accounts have a long way to go to beat the traditional pension. Other major impacts on your savings decision would be your age, earnings and chosen retirement date.
The table below might help you decide the best option for you:
|Tax relief or equivalent on contributions
||Up to 45%
||25% up to age 50|
|Maximum contribution per annum||Between £10,000 and £40,000 depending on income
||£16,000 (including the Lifetime ISA contribution)
|Tax on income/growth while invested||Tax free
|Tax in withdrawal||25% lump sum tax free plus income tax on ongoing pension
|Minimum withdrawal age||55||Not applicable
|IHT||Potentially tax free
||Tax up to 40% of fund value
||Tax up to 40% of fund value|