Whether the Lifetime ISA works for you as a pension — as an alternative or complementary savings option — is complicated, and depends on several factors.
You will need to consider your personal situation, your employment and your tax status. We cover the key points here; if you’re unsure, please seek independent financial advice.
Lifetime ISAs and pensions are taxed differently.
With a pension, you pay in with pre-tax money, or get the tax back when you contribute. You get tax relief on the whole contribution. You pay no tax on the first 25% you withdraw, but you’re taxed on the rest when you withdraw it.
A Lifetime ISA is the other way around: you contribute money you’ve already paid tax on, but eligible withdrawals are tax-free.
For both there is no tax to pay on any interest, dividends or capital growth earned before the money is withdrawn.
If you’re employed, you may receive employer-matched contributions towards your workplace pension. Your employer has no obligation to make and/or match contributions to your Lifetime ISA.
As a rule of thumb, if you’re employed, continue to pay into your workplace pension and reap the benefits of the employer-matched contributions. These contributions are likely to outweigh the Lifetime ISA 25% government bonus.
As a higher rate taxpayer, you get 40% tax relief on your pension. Additional rate taxpayers get 45%. This saving easily beats the government’s 25% top-up on Lifetime ISA contributions.
A pension, as according to current HMRC rules, you’re allowed to access your money once you’re 55. Please note that this minimum age may change before you reach 55.
With the Lifetime ISA, you can access your money at any point if you need it, but you will pay a penalty if you choose to withdraw it before you’re 60 and it’s not to buy your first home, or because you’re terminally ill. Take a look at Can I access my savings?
If you’re self-employed, you won’t have a workplace pension and you won’t benefit from employer-matched contributions. So a Lifetime ISA — and the 25% government bonus — may win over a stakeholder pension or SIPP.
However, the more suitable option for you will also depend on your tax status and personal situation:
If you’ve maxed out contributions on your workplace pension and you want to save more, the Lifetime ISA could be a good option.
As you must pay tax if the savings in your pension pots exceed £40,000 in a year, or £1 million in total, if you’re going to reach either of these pension limits, the Lifetime ISA might work as a good complementary way to save for later in life.
If you’re unsure of what you’re saving for, the Lifetime ISA offers more flexibility than a pension: you can use it to save towards buying your first home, retirement, or both. A pension is only for retirement.
If you need to access your money ‘early’ (and not because of a critical illness or death), and you’re willing to pay a penalty, the Lifetime ISA wins. Other than critical illness or death, pensions don’t allow early withdrawals.
However, if you already think there is a good chance you’ll need to access the money, you may be better off with a normal ISA as you’ll have to return the government bonus and pay a penalty.
According to the government’s rules, you will be able to access your Lifetime ISA funds from abroad once you are sixty without penalty.
But bear in mind that as with any ISA, you cannot contribute if you are not UK resident.
|Age to open one||18–39||Any age, but usually when you start working|
|Annual contribution limit||£4,000||The annual allowance is £40,000 per year, but may be lower for those with income of more than £150,000.|
|Government contribution||25% bonus on annual contributions||Tax relief on contributions up to your ‘relevant earnings’ (not including rental income, interest or dividends)|
|Employer contributions||None||A minimum of 1-3% for auto-enrolment. More about pension employer contributions|
|Max contribution age||49||None. Although once you’re 75 you no longer get tax relief on contributions|
|Lifetime savings limit||Contributions: £128,000
Government bonuses: £32,000 (Assuming you open one when you’re 18)
|£1 million — the lifetime allowance. Includes your contributions, employer contributions and investment growth|
|Use of savings||To buy first home less than £450,000, once you’re 60, if you’re critically ill||Anything you want, once you’re eligible to access your savings. However, after withdrawing the first 25%, withdrawals will be taxed as income.|
|Age to access savings||Any age, but if you want to access your money before you’re 60 and it’s not to buy your first home or a critical illness you will incur a 25% penalty||55|
|Investment options||Cash ISA or stocks and shares ISA||Investment options are varied and include more than those of a Lifetime ISA. The main exclusions are residential property and ‘tangible moveable assets’ such as antiques and paintings.|
|Tax on interest earned / investment growth||None||None, provided the total value is within the lifetime allowance|
|Tax relief||Tax-free withdrawals||Tax-free when you pay into it, taxed when you withdraw|
|Early / ineligible access penalty||A government penalty of 25% on the total value of the withdrawal||No early access allowed, except for certain circumstances such as poor health, if you’re in a profession with a low retirement age, or if you have a protected pension age.|
|Funds accessible if living abroad when 60||Yes||Yes|
|Contributing to someone else’s||Yes||Yes|
|Inheritance tax benefits||Only for your spouse||Yes — it doesn’t form part of your estate when you die|
A Lifetime ISA may not be right for everyone
As with all investing, your capital is at risk. Tax rules may change in the future. If you are unsure if a Lifetime ISA is the right choice for you, please seek independent financial advice.