LISA or Pension? An Investment Guide for Beginners
Announced by then chancellor, George Osborne as part of the 2016 Autumn Budget, the Lifetime ISA (LISA), has had a strong first year. According to a weekend report in The Sunday Times’ Money section, more than 100,000 LISAs have been opened over the first year of the new ISA sub-category. The LISA, contributions into which are capped at £4000 annually and form part of the larger £20,000 general ISA allowance, is open only to the under-40s. It benefits from an additional 25% government top-up to contributions, which regular ISA contributions do not, and is intended to be used towards either the deposit on a first property or retirement. If £4000 is paid into a LISA, this is topped up to £5000 by the 25% state contribution. Like regular ISAs, LISA contributions can be either held in cash or invested in shares, funds and other select investment vehicles.
Many, probably most, new LISA holders intend to use the tax-efficient savings vehicle to buy their first property. Skipton Building Society has said that among their LISA holders, 75% have said this was their objective in opening a wrapper account. This application of funds is the LISA’s greatest strength as there is no restrictions or tax due on withdrawals of used for this purpose. In contrast to Skipton’s LISA customers, online investment platform AJ Bell says half of its LISA holders are aged between 36 and 39. This means a large portion of them have presumably already bought their first property and LISA savings are intended for retirement. How does a LISA compare with a pension wrapper if funds are earmarked for retirement rather than a first property deposit? This is where things get a little more complicated and the optimum choice depends upon a range of factors.
A strength of making pension contributions is that not only do they benefit from a 20% government top-up, if you are a basic rate income tax payer, but your employer must also contribute. And there’s an annual cap of £40,000, not £4000. Tax relief rises to 40% and 45% for higher earners. However, for those earning over £150,000, pension tax relief is tapered and applies to gradually smaller sums down to a minimum of £10,000 for those earning £210,000 or more. For those who do not earn over £150,000, paying into a pension becomes more valuable.
For those who are self-employed, however, and do not receive company pension contributions, there is no difference in the financial incentive of paying into a LISA or pension, at least until the age of 50 when a LISA can no longer be paid into. Unless you are a higher rate tax payer and can take advantage of 40% or 45% tax relief on pension contributions. Another drawback of a LISA is that it cannot be accessed until the age of 60, while a pension can be accessed from the age of 55. However, after the age of 60, funds taken out of a LISA are not subject to income tax and pension funds are taxable.
A LISA can also offer an additional option for those who have used up their lifetime pensions limit of £1 million or annual £40,000 contribution cap. It is important to work through all of these variables if deciding between a pension or LISA for retirement funds in order to decide which is the best option for your personal situation. As a vehicle to save up for a first home deposit though, the LISA is a great addition to the tax efficient ‘wrapper’ products that benefit from government incentives.
Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.
There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.