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 April, the government is introducing a new savings product called the Lifetime Individual Savings Account (LISA). LISAs provide a long-term savings account for big life events like buying your first home and retiring.

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 nine of the most common questions.

1. What is a lifetime ISA?

Lifetime ISAs are available from 6 April 2017, offering a new option for consumers looking to save money long-term. LISAs are tax-free and the government provides a bonus of 25% on the money you put in. So, for every £4,000 you put into your LISA, you receive a £1,000 bonus.

You’ll be able to open a LISA if you’re aged between 18 and 40. LISAs are designed to fund long-term life goals so you can withdraw money without fees if you’re buying your first home or if you’re retiring after age 60.

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. There are lots of differences between LISAs and pensions but the key distinction is that pensions can only be used for retirement whilst LISAs can also be used for buying a first home.

If you’re considering a LISA for retirement, it’s a good idea to compare this new product with pensions to find out what option works best for you.

3. What tax relief do I get?

The Lifetime ISA, like all ISAs, is a tax-free savings account. You won’t be taxed on what you put in, and you receive a 25% bonus on your savings. You’ll get a £1 bonus for every £4 you put in. This bonus is equivalent to the tax relief offered by pension funds. For people on higher incomes or a larger pension pot, pensions can offer better tax benefits overall.

You can put up to £4,000 into a LISA every year, so the maximum bonus you can receive each year is £1,000. In addition to this limit, you can’t pay more than £20,000 per year across all your ISAs. In comparison, you can contribute as much and as often as you want towards a pension, but there are limits to how much you can save before you are taxed on income.

For most taxpayers, you receive tax relief on pension contributions up to £40,000 each year. For high earners, there is 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 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, you can move your money into income drawdown, which means your pension money remains invested, and 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 the criteria. This high charge means you will lose your bonus on any early withdrawals.

5. So when can I withdraw money?

The Lifetime ISA allows you to spend your savings on a new home or retirement. You are also allowed to withdraw funds early, without a charge, if you are terminally ill or transferring your ISA to another provider.

If you want to buy a home with your savings, it must be your first home and you must be buying a mortgage. The funds also need to go through a solicitor. This may be a good option for first-time buyers on average incomes. In the first year of the LISA, people who already own a Help-To-Buy ISA can transfer into a LISA without charges or limits.

If you want to open a LISA for retirement, you will only be able to access your money after age 60. In comparison, you can access your pension once you reach age 55. In retirement, 25% of your pension pot will be available to you tax-free, whilst the rest is taxed as income. Similarly to a LISA, you can only withdraw your pension early if you are terminally ill.

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 will be a 25% charge if you are not using your money for your first home or retirement.

Access to your savings can help you decide 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?

With a workplace pension, your employer can make contributions to your pension which often amount to more than the maximum £1,000 bonus you can receive with a LISA. Employers are unable to make contributions into a LISA so this can reduce your savings overall.

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, however, will only have to pay tax on your savings if you die after age 75. Depending on your circumstances, inheritance tax rules on LISAs might be an important factor in making your decision.

9. So should I open a Lifetime ISA or a pension?

LISA or 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 cash-only LISA could reduce the potential for growth in your savings

Consider your lifestyle and life goals, such as whether you want to prioritise your first home or your retirement. Think about where you are in life already. Depending on your age and whether you’re already a homeowner, a LISA may not offer enough flexibility or scope for growth. If you have existing plans for retirement, including existing pensions or ISAs, you may need to consider how this affects other long-term saving plans.

Other financial products can impact your decision-making process. For instance, if you already have a Help To Buy ISA, you can use it in conjunction with a LISA. However, you can only use the bonus from one of them to purchase your first home. And if you have existing pensions, it might be more beneficial for you to consolidate them into a single new plan, than to buy another product to add to the pile.

If you’re interested in long-term saving for retirement, you may want to consider one of the PensionBee pension plans.

What do you make of the new Lifetime ISA? Tell us in the comments section at the bottom of the page.

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