Your guide to Lifetime ISAs and pensions

Zainabb Hull

by , Community and Content Executive

at PensionBee

21 Mar 2017 /  

Your guide to Lifetime ISAs and pensions

This article was last updated on 16/06/2023

The Lifetime ISA or ‘LISA’ was introduced in April 2017 with the idea of providing a long-term savings option for two big life events; buying your first home or retirement.

If you’re wondering how exactly LISAs work and how they stack up against pension funds, you’re in the right place. In this guide we’ll answer some of the most common questions.

Financial Times Consumer Editor; Claer Barrett says: “You can use that (LISA) to put towards your first home, so long as it’s worth less than £450,000, which has caught a lot of people out.”

1. What’s a Lifetime ISA?

LISA stands for ‘Lifetime Individual Savings Account’ and is a type of ISA or ‘Individual Savings Account’. ISAs allow you to save money into an account without having to pay tax on your contributions and interest earned.

Like other ISAs, LISAs are also tax-free, but differ in the fact that they give further incentives to those who’re either buying a house for the first time or looking to save a bit extra for when they retire. When you put money into a LISA, the government will provide a bonus of 25%. So, for every £4,000 you put in, you’ll receive an extra £1,000.

You’ll be able to open a LISA if you’re aged between 18 and 40. They’re designed specifically to fund these long-term life goals, so you won’t pay any fees if you withdraw your money to buy your first home or if you’re retiring after age 60. However, if you withdraw for any other reason, you’ll accrue a penalty of 25%. Effectively taking away any bonus that you earned from the government.

2. How do LISAs compare to pensions?

Pension funds are still the most popular long-term savings product for retirement, offering tax relief and the room for growth.

One of the key differences between LISAs and pensions is that pensions can only be used for retirement whilst LISAs can also be used for buying a first home.

Another factor’s the distinction between how much money you’ll be able to contribute to either product. With a LISA, you’re limited to contributing a maximum of £4,000 per year. With a pension there isn’t a limit, though if you exceed your annual allowance, you won’t get tax relief on anything over that amount.

3. What tax relief do I get?

LISAs are tax-free savings accounts. You won’t be taxed on what you put in, and you receive a 25% bonus on your savings, so for every £4 you put in, you’ll receive a £1 bonus. This is equivalent to the tax relief offered by pension funds. For people on higher incomes or with larger pension pots, pensions can offer better tax benefits overall.

For most taxpayers, you receive tax relief on pension contributions up to £60,000 each year. For high earners, there’s a tapered limit. The highest earners receive tax relief on pension pots up to £10,000.

4. Will I pay tax on withdrawals?

From the age of 55 (rising to 57 from 2028) you can take up to 25% of your pension as a lump sum without paying tax. If you take out more than this you’ll have to pay income tax. Alternatively, if you make withdrawals via income drawdown, where your money remains invested, you can take taxable income from it as and when you want. If you do this without taking the 25% tax-free lump sum first, you can get 25% of each withdrawal tax-free.

Money in your LISA will remain tax-free no matter what, but you can only make withdrawals in specific circumstances. You’ll have to pay a 25% fee every time you withdraw outside of these criteria.

5. So when can I withdraw money?

If you’re using the savings in your LISA to buy a home, it must be your first home and you must be buying a mortgage. The funds also need to go through a solicitor. If you already own a Help-to-Buy ISA, you can transfer it into a LISA without charges or limits. You can now no longer open a new Help-to-Buy ISA.

If you want to open a LISA for retirement, you’ll only be able to access your money after age 60. In comparison, you can access your pension once you reach age 55 (rising to 57 from 2028).

With LISAs, you can only withdraw outside of these criteria without a charge in exceptional circumstances, such as if you become terminally ill. This is also the only exception in which you can withdraw from a pension before the age of 55.

6. What if I need to access my money?

ISAs generally allow for early access to funds which makes them popular options for mid-term saving. The LISA is no different; you can access your money at any time, but there’ll be a 25% charge if you’re not using your money for your first home or retirement.

It’s important to think about your long and short term goals when it comes to deciding what savings option works best for you. In an emergency, it can help to be able to withdraw your money. On the other hand, restricting access until retirement means that your money stays safe until you need it.

7. What about my workplace contributions?

One advantage of workplace pensions is that your employer will make contributions alongside your own. Depending on what percentage they contribute, which at minimum has to be 3% of your qualifying earnings, it’s possible that this can amount to more than the maximum £1,000 bonus achievable with a LISA.

Financial Times Consumer Editor; Claer Barrett says: “At the moment, and I say at the moment cause I think it’ll probably be taken away in the future, there are amazing tax benefits if you leave somebody your pension.”

8. Does inheritance tax apply to LISAs and pensions?

LISAs are subject to inheritance tax rules whilst pensions are exempt. This means that when you die, money held in your LISA can only be passed onto a spouse or civil partner tax-free. Other beneficiaries will have to pay inheritance tax.

Beneficiaries of your pension will only have to pay tax on your savings if you die after age 75. However, it’s important to note that when you die, your pensions do not form part of your estate which means you’re unable to include them in a will. You’ll instead need to fill out an ‘expression of wish‘ form with your pension provider to state who you’d like to receive your remaining pension.

So should I open a LISA or a pension?

Ultimately, there are a lot of personal factors that will affect your decision to either open a LISA or invest in a pension. Your individual circumstances will determine which option is best for your long-term savings.

A key consideration might be whether you want to prioritise your first home or your retirement. If you’re already a homeowner, then you’d only be able to use a LISA for retirement. If this is the case, you might perhaps consider saving into a LISA alongside your pension, acting as a top-up to your income when you reach age 60.

Other financial products can impact your decision-making process. For instance, you may already have other ISA products. Although you can save into a LISA alongside other types of ISA, each individual has a savings limit of £20,000 each year across all of their ISAs. This includes the maximum of £4,000 per year that you can pay into your LISA.

If you’re finding it hard to keep track of all of your savings accounts, it might be more beneficial for you to consolidate your pensions into a single new plan, than to buy another product to add to the pile.

If you’re still unsure, then you can learn more about the differences between LISAs and pensions from financial experts on our special episode of The Pension Confident Podcast. You can also read the transcript or watch the episode on YouTube to help clear up any questions you have about the different types of ISAs and pensions.

Risk warning

As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. Anything discussed on the podcast should not be regarded as financial advice.

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