It’s a question which Kay Ingram, Director of Public Policy at national financial planning group LEBC, has shared her insight on this week. In the latest of her series of Insights alerts, the chartered financial planner explained what the pros and cons are when it comes to the two options.
“A narrowing gap between the age at which savers can gain penalty-free access makes the choice less clear, especially as LISAs pay out tax-free but pensions are partly taxable,” commented Ms Ingram.
“In an ideal world, having both a pension and a LISA would be the best option, but if savings are limited, people may wish to consider a number of points when choosing how best to boost retirement savings with taxpayer handouts.”
“For nil or basic rate taxpayers, the LISA and pension offer the same taxpayer bonus of 20 percent, so that £8 saved is worth £10 invested,” Ms Ingram said.
“Both offer the same tax-free roll up of funds, with no tax to pay on fund growth or income.
“When the money is paid out the LISA has the advantage of offering a tax-free income, whereas 75 percent of the pension paid out is treated as taxable income.”
“Those without earnings can save £4,000 a year into a LISA; however, if they have no earned income, they can save only £2,880 into a pension, so the taxpayer subsidy is up to £720 a year in a pension but up to £1,000 in a LISA.”
“For employees, joining a workplace pension offers the added advantage of a tax-free employer contribution.
“Employees earning over £10,000 a year, between the age of 22 and 66, must be offered a pension scheme, with the employer paying three percent of earnings; the employee pays four percent and tax relief adds a further one percent.
“Many employers offer more generous schemes and not joining or opting out is giving up ‘free money’. Employers cannot pay into a LISA.”
Higher rate tax
“Those paying tax at a higher rate get a bigger bonus from pension savings.
“A higher rate taxpayer sees £6 saved grow to £10, and for a top rate taxpayer, £10 saved costs just £5.50.
“Scotland resident taxpayers can gain an extra one pence in the pound as they pay tax at 21 percent, 41 percent and 46 percent respectively.”
“Where more than £4,000 is available for saving long term, those with earnings or self-employed profits can save in a pension the lower of their earnings/profits in the year or £40,000 into a pension, but only £4,000 into a LISA.
“LISA savers can pay in and earn the bonus only between the age of 18 and 50.
“Pension savers can start at birth and continue until 75.
“Starting a LISA before the age of 40, then funding a pension from the age of 50, could provide a good combination of tax-free income from the LISA and taxable income from the pension.
“If the pension and other sources of income fall below the personal allowance for income tax (currently £12,500), all the income could be tax-free.”
“The LISA offers access before the age of 60, with a lower penalty than applicable if a pension was accessed prior to age 55 (57 from April 2028).”
“LISAs cannot be continued beyond death and form part of the taxable estate.
“Pension funds can be left to others to continue, with tax-free investment, and do not usually form part of the taxable estate.”
“Choice of LISA providers is more limited and most offer only a cash deposit option.
“For long term saving a stocks and shares LISA has more potential to maintain its purchasing power alongside inflation, but could go down in value in the short term.”
Ms Ingram added: “Ideally savers should consider both options.
“There are clear advantages in maximising workplace pension savings first and higher rate taxpayers will get a bigger bonus from pension saving.
“However, should The Budget on March 3 end higher rate tax relief, the attraction of the LISA, which pays a tax-free income in retirement, will be greater.”