Your guide to Lifetime ISAs and pensions

The Lifetime ISA (LISA) was introduced in April 2017 as a long-term savings option for two big life events; buying your first home or retirement. If you’re wondering how LISAs work and how they stack up against pension funds, you’re in the right place.

1. What’s a Lifetime ISA?

A LISA is a type of Individual Savings Account (ISA). ISAs allow you to save or invest money without having to pay tax on your contributions and interest earned or investment returns generated.

Like other ISAs, LISAs are also tax-efficient, but differ in the fact that they give further incentives. 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 39. 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%. That effectively removes any government bonus, as well as any interest or investment returns on your LISA savings.

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.

There are also different annual contribution limits. With a LISA, you’re limited to contributing a maximum of £4,000 per year. And this counts towards your annual ISA limit of ^{_isa_allowance} (^{_current_tax_year_yyyy_yy}).

With a pension there's the annual allowance. This is the limit on the gross amount that can be saved into a pension each tax year without incurring tax charges. The current standard annual allowance for pension contributions is ^{_annual_allowance} (^{_current_tax_year_yyyy_yy}) - this includes personal, employer and any third party contributions.

3. What tax relief do I get?

LISAs are tax-efficient saving or investment accounts. You won’t be taxed on what you put in, and you receive a 25% bonus on your contributions. So for every £4 you put in, you’ll receive a £1 bonus.

With pensions, most taxpayers usually receive tax relief on pension contributions. There’s a separate limit to the annual allowance on tax relief. You can receive tax relief on personal and third party contributions up to 100% of your salary, capped at ^{_annual_allowance} per year (^{_current_tax_year_yyyy_yy}).

For higher earners, there’s a tapered limit. The highest earners only receive tax relief on pension contributions up to £10,000 (^{_current_tax_year_yyyy_yy}).

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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 tax-free lump sum. If you take out more than this, you may 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.

Withdrawals from LISAs are tax-free, but you can only make them in the specific circumstances described above. 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 with a mortgage. The funds also need to go through a solicitor.

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.

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 under 60 and not using your money for your first home.

With a pension, you generally don't have this flexibility, and you won't be able to touch your savings until 55 (rising to 57 in 2028) in most cases.

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. The longer you leave your money invested, the more chance it has to benefit from compound interest.

7. What about my workplace contributions?

One advantage of workplace pensions is that your employer will make contributions alongside your own, provided you're eligible for Auto-Enrolment. Your employer is required to pay at least 3% of your qualifying earnings into your pension. Although some will go above and beyond and offer matched pension contributions.

You won't benefit from employer contributions into your LISA.

8. Does Inheritance Tax apply to LISAs and pensions?

LISAs are subject to Inheritance Tax (IHT). 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 may have to pay IHT, depending on the total size of your estate.

Currently, pensions are considered to sit outside your estate, which means that when you die your beneficiaries can access your retirement savings without having to pay IHT. However, this position is set to change from April 2027. We don't yet know exactly how these changes will work in practice when they come into effect.

It’s important to note that, as of ^{_current_tax_year_yyyy_yy}, pensions don’t form part of your estate. You can choose to mention your pension in your will if you want to eliminate any doubt over your wishes, but it’s recommended that you fill out an ‘expression of wish‘ form with your pension provider. This states who you’d like to receive your remaining pension.

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. Your LISA withdrawals in later life will also be tax-free, potentially making them useful for creating a tax-efficient retirement income alongside your pension.

Other financial products can impact your decision-making. 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 ^{_isa_allowance} each year (^{_current_tax_year_yyyy_yy}) 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 and you have a couple of pensions, it might be more beneficial for you to consolidate them into one plan.

Learn more about the differences between ISAs and pensions with this special episode of The Pension Confident Podcast. You can also read the transcript or watch the episode on YouTube.

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.