Choosing between a Lifetime ISA or pension could be your golden ticket for retiring in style, so let’s learn about the ins and outs of these long-term saving instruments.
Lifetime ISA includes a hefty government-backed bonus (up to £1,000 a year), and people who are saving for their first home could benefit from using these saving options.
Pensions are a well-established retirement-planning option, offering tax relief, employer contributions, and the potential for steady long-term growth.
Choosing between a Lifetime ISA and a pension depends on the individual’s savings goals and circumstances, but other factors like age and income could also affect the decision.
So, without further ado, let’s review the two popular options Brits have for retirement savings.
Lifetime ISA vs Pension: What’s the Difference?
The earlier you start with retirement planning, the better. However, choosing between a pension and a Lifetime ISA can be challenging if you don’t know the pros and cons of these plans.
But before we dive deeper into each account type, we should explain how the concepts differ. Namely, Lifetime ISA is a relatively new long-term saving method that includes a 25% bonus on savings. In addition, you can withdraw the funds from a Lifetime ISA fee-free when buying your first home, which is not possible with a pension.
Sounds interesting? It gets better, so let’s get down to brass tacks.
What Is a Lifetime ISA?
Lifetime ISA is a savings account available only for UK residents aged 18 to 40. As the name suggests, it is aimed at long-term savers – you can withdraw money for only two reasons:
You’ve turned 60.
You’re placing a deposit for your first home.
With Lifetime ISA, UK savers can deposit up to £4,000 a year, with the maximum lifetime contribution at £128,000. On top of that, the government will add a 25% bonus on your deposits at the end of each tax year.
Cash Lifetime ISA – Lets you collect the 25% monthly government bonus and earn interest tax-free with the cash handled by Lifetime ISA providers. In other words, Cash Lifetime ISA works like traditional cash savings accounts.
Stocks and shares Lifetime ISA – Lets you collect the 25% monthly government bonus with the money handled by experts and invested in stocks, shares, funds, or bonds. Your investment value could go up or down, but you also get to manage the portfolio and make informed decisions.
What Is a Pension?
Unlike Lifetime Individual Savings Accounts, where employers cannot add to your account, the traditional system relies on employer pension contributions. Thanks to the auto-enrollment feature, all employed people in the UK will have 3% of their monthly salary automatically added to their retirement savings.
Besides workplace pensions, UK savers can also have self-invested personal pensions (SIPPs). The limit for yearly contributions to UK pensions stands at £40,000, and the best pension providers will invest your funds in equities for guaranteed long-term growth.
And while the UK government doesn’t add a bonus to your pension, you’ll get another vital benefit — tax relief, which we’ll discuss this aspect in more detail below. Any UK resident over 18 can start a pension, and you can even start it on behalf of your child.
What Is Better — a Lifetime ISA or a Pension?
Before taking the plunge and opting for one, UK savers should consider the pros and cons of Lifetime ISAs and pensions. After all, neither saving method is ideal, but each has its perks.
For instance, Lifetime ISA includes a generous government bonus, perfect for those planning to grow the money before buying their first home. Also, this savings instrument could be an ideal self-employed pension solution in the absence of a standard workplace pension.
On the other hand, traditional pensions have much higher contribution limits, and you can access the funds earlier than with a Lifetime ISA. Those who are enrolled in a workplace pension scheme receive contributions from their employer, which is a valuable benefit.
The idea is not for Lifetime ISA to replace a pension, as LISA primarily acts as an alternative retirement-planning product. So, here’s what to know as you prepare for a comfortable retirement.
Accessing Your Money
The hefty 25% bonus attracts many UK savers, but Lifetime ISA has several downsides you shouldn’t ignore. Notably, you will lock away your funds until the age of 60. In comparison, the withdrawal threshold for traditional pensions is 55 (increasing to 57 by 2028).
In addition, savers could take the money out of a Lifetime ISA without penalties for buying their first home. Any other withdrawal will incur a 25% charge, but you are otherwise free to access the money at any time.
But even though Lifetime ISA has a higher threshold and a hefty charge, it beats traditional pensions regarding flexibility and money accessibility. Namely, withdrawing the funds from a pension before retirement entails a 55% penalty by HMRC.
Tax Considerations
Since you don’t pay tax for your savings locked in a Lifetime ISA, you don’t need to worry about taxes with these accounts. Yet, even though there’s no tax on investment returns, interests, or withdrawals, you already had to pay income tax on the money you put into Lifetime ISA.
In comparison, traditional pensions will let you postpone the taxes until retirement – you only pay taxes on withdrawals. Moreover, the first 25% is completely tax-free for a basic-rate taxpayer as long as you withdraw a lump sum and don’t exceed your personal allowance.
Therefore, a traditional pension could better fit long-term savers, given that a Lifetime ISA only seems tax-free initially. Then again, the initial 25% bonus on Lifetime ISA could balance out basic-rate income tax for pension withdrawals. So, the choice between the two account types depends on your specific financial circumstances.
Could You Have Both?
If you can afford to pay for both products, having a pension and a Lifetime ISA could provide the best of both worlds. In this scenario, you would benefit from the government-issued bonus and employer-paid contributions, and can consolidate both pension accounts into one in the future should you need it.
In addition, many savers could benefit from different withdrawal thresholds for Lifetime ISA and pensions. Remember, you can access pensions earlier (55 vs 60), and you can also contribute after the age of 50. On the other hand, you can’t deposit into a Lifetime ISA after your 50th birthday.
Arguably, the best tactic is to use Lifetime ISA when saving for a home and stick with pensions for retirement planning.
Best of all, more companies offer personal pensions than Lifetime ISAs, with the best UK pension providers offering competitive fees and various money-saving perks.
Making Your Final Pension Decision
And there, you have it — a comprehensive overview of the pensions and Lifetime ISAs. We covered the nuts and bolts of each saving vehicle, explaining the finer points so you can invest your money worry-free.
As you can see, Lifetime ISA is a mixture of the classic Individual Savings Accounts and traditional pensions. As such, this savings product could be ideal for first homeowners saving for a deposit. In most other cases, sticking with workplace contributions or opting for a personal pension is the recommended path.
