ASK TOM

AJ Bell ex­pert Tom Selby com­pares the two sav­ings ve­hi­cles

Shares - - CONTENTS - By Tom Selby Tom Selby, AJ Bell Se­nior An­a­lyst

‘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.

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