ISA, LISA or Pensions – Which one should you choose?

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Whilst existing pension rules escaped further amendments in the last budget, they were given some competition through an increase in the annual ISA allowance and the introduction of new Lifetime ISA (or LISA).

Whilst the LISA is aimed solely at younger savers, as the government continues to encourage a culture of saving, workers now have more options than ever before about where to put their savings. But which of these options is the best place for your money?
Below is an overview of the new LISA and how it compares to traditional pension saving options.

HOW DOES THE LIFETIME ISA WORK?

The LISA is available to anyone aged between 18 and 40 as of 6 April 2017 and is designed for two specific purposes:

  • For first-time buyers to put towards a residential property worth up to £450,000
  • To take out for retirement once you hit 60

With both options there is no tax to pay and the government will add a 25% bonus on every £1 you save up to a maximum of £4,000 per year until you reach the age of 50. If you were to save the maximum amount per year, the £5,000 saved, including the state top-up, will count towards the new £20,000 ISA limit (which is set to increase from £15,240 next April).

If using the money to buy a home, it can be accessed tax-free at any time (providing it’s been held for 12 months or more). If you choose to use the money for retirement, it can be accessed tax-free after the age of 60, but if you choose to access it before that, the government bonus will be lost, including any interest or growth, and subject to a 5% charge.

HOW DOES A LISA COMPARE TO A PENSION?

As with a standard ISA, you can opt for a cash or investment LISA option – however standard ISA’s don’t offer the 25% bonus the LISA does. E.g. saving £100 into an ISA costs £100, whereas saving £100 into a LISA would only cost £80 due to the government contribution.

With a pension you save from gross income, so as a basic rate tax-payer you only have to put in £80 to save £100. With a LISA you save from net income, so to put in £80 costs you £80, but with the government top up you end up with £100. Exactly the same. However higher-rate taxpayers get relief at 40% in a pension. So to contribute £100 only costs them £60 – easily beating a LISA.

What’s more, if you’re employed, auto-enrolment means your employer has to match some of your contributions in a pension; they don’t in a LISA. Furthermore, the LISA contribution stops at age 50, whereas a pension will contribute until you retire.

Conversely, when you take your pension, you can only take 25% of it as a tax-free lump sum – the remaining 75% is taxed at your rate of income. However, with a LISA, you can withdraw the full amount totally tax-free (once you pass the age of 60). LISA’s are also more flexible, as you have the option to use the cash that you’re saving towards your first home towards retirement too.

Here is a table summarising these variations:

  Lifetime ISA Pension – basic-rate taxpayer Pension – higher-rate taxpayer
Employer contribution None Yes – 1-3% of salary Yes – 1-3% of salary
Government contribution 25% 25% (tax relief) 66% (tax relief)
Max amount you can you save/yr? £4,000 £40,000 (max amount with tax relief) (1) £40,000 (max amount with tax relief) (1)
When is bonus/tax relief paid? End of each tax year Immediately Immediately
Who can open one? Anyone aged 18-39 Anyone aged 16+ Anyone aged 16+
When can you access it? Age 60 (accessible before, for a penalty) Age 55 Age 55
Tax treatment on pay-in From post-tax income From pre-tax income From pre-tax income
Tax treatment on withdrawal Tax-free 25% tax-free, rest taxed at your income tax rate 25% tax-free, rest taxed at your income tax rate
Liable for inheritance tax? Yes No No
Affects pre-pension age benefits entitlement? Yes No No
Can be taken to pay creditors in bankruptcy? Yes No No
(1) You can carry unused allowances over from previous years, meaning that technically you could contribute up to £170,000 in the 2016/17 tax year. However, you’d need to earn at least this to get this much tax relief.

Source: http://www.moneysavingexpert.com/savings/lifetime-ISAs

With both options offering their own advantages, the best option will depend on your personal circumstances. As a general rule, it is better to have a pension over a LISA alone but there is nothing stopping you having both. Those in employment will benefit more from continuing to pay into their workplace pension scheme, and those who are self-employed or high earners will also get better tax breaks from a pension versus the 25% bonus offered by a LISA. That said, if you are between the ages of 18 and 40, and want an extra source of income after the age of 60, then a LISA could be great option to look at.

For more advice on ISAs, LISAs and pensions, speak to your Finura Partners advisor today.

Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

Other sources.

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