AJ Bell expert Tom Selby compares the two savings vehicles
‘Which is better: a Lifetime ISA or a pension?’
Greavesy from Beverley:
‘I’ve been thinking about opening a Lifetime ISA but I’m not sure if it’s the right thing to do. Will I get more compared to a pension? And how does the exit penalty work?’ Any UK resident aged 18-39 is eligible to open a Lifetime ISA and pay in up to £4,000 a year. This money will automatically be topped up by a 25% Government bonus, up to a maximum of £1,000.
Once you have opened a Lifetime ISA you can keep paying in until the day before your 50th birthday and receive the 25% bonus. After this point, you can no longer make further deposits. This means someone who pays in the maximum to a Lifetime ISA each year could benefit from £32,000 in bonuses over their lifetime.
Withdrawals are tax-free if the money is used to fund the purchase of your first home (provided it is worth £450,000 or less, is in the UK and bought with a mortgage), after your 60th birthday or if you become terminally ill.
Any other withdrawals will be hit with a Governmentimposed exit penalty of 25%. Because that’s 25% of all the money you take out, you could end up losing more than the Government bonus.
Let’s run through the example of someone saving the maximum £4,000 in a Lifetime ISA in one year and so had that topped up to £5,000 by the Government. We assume there was no investment growth.
If they took all the money out in circumstances other than a first home purchase, terminal illness or reaching their 60th birthday, the entire £5,000 would be hit with a 25% penalty. That means £1,250 would go back to the Government – meaning they’ve lost the £1,000 bonus and a further £250 on top.
When it comes to saving for retirement, there are a number of things to consider. Firstly, most people in employment are automatically enrolled into a workplace pension where they receive a contribution from their employer.
There is no similar employer contribution for a Lifetime ISA, so if you are considering a Lifetime ISA instead of, rather than in addition to, a workplace pension you will almost certainly be better off staying in your workplace scheme.
Higher and additional-rate taxpayers get a larger bonus (in the form of tax relief) from a pension than a Lifetime ISA, although only 25% of pension withdrawals are tax-free from age 55, with the remaining 75% taxed in the same way as income.
If you’re a basic-rate taxpayer the bonus for saving in a pension and a Lifetime ISA is identical, and with tax-free withdrawals – albeit from age 60 – a Lifetime ISA could be worth considering depending on your personal circumstances. A Lifetime ISA could also prove a useful alternative vehicle for anyone at risk of breaching the £1.03m pensions lifetime allowance.
You still need to consider that investment returns from both a pension and a Lifetime ISA are unpredictable.