For long-term savings, there are plenty of products vying for your attention, but which one should you choose? This article takes you through everything you need to know about pensions versus Lifetime ISAs, so you can work out which option is best to help you build a secure retirement.
Should I invest in a pension or a Lifetime ISA?
For ease of comparison, the table below sums up the main differences between pensions and Lifetime ISAs. We’re talking here about private pensions rather than the state pension, which everyone gets as long as they have paid enough National Insurance Contributions over their working life. Obviously, there will be much more detail to consider depending on, for example, the type of pension you choose and the provider which offers it, but this should give you a rough reference point.
|Comparison points||Pension||Lifetime ISA (LISA)|
|Eligibility||Anyone can have a pension. Employees can enrol into their workplace scheme, and anyone can open their own private pension such as a SIPP.||Anyone can open one but you must be aged 18 or over and under 40. You can pay in and get the bonus until you are 50.|
|What’s it for?||Saving for retirement.||Either to save to buy your first home (worth less than £450,000), or for retirement.|
|Max you can save||100% of your earnings, up to £40,000 a year. Over your lifetime, the limit is £1,073,100 for 2021/22||£4,000 a year. This forms part of your £20,000 annual ISA allowance. You can pay in lump sums or make regular deposits.|
|Perks||Employers must pay in 3% when workers pay in 5% of qualifying earnings.||Government pays you a 25% bonus on contributions.|
|Tax breaks||You get tax relief on pension contributions of 20% as a basic-rate taxpayer, 40% as a higher-rate taxpayer and 45% as an additional-rate taxpayer. No tax to pay on the first 25% of the pot you withdraw, but you will pay tax on the rest.||You don’t get tax relief on contributions, but withdrawals are tax-free.|
|Withdrawal restrictions||You can’t withdraw until age 55.||You cant withdraw until age 60 unless it is to purchase your first home or if terminally ill; otherwise, you'll pay a 25% penalty.|
|Anything else||There are lots of different types. You can transfer your pension to another provider or consolidate pots.||You can have a cash LISA or a stocks and shares LISA. You can hold a LISA alongside other types of ISA.|
Now to answer a few of the commonly asked questions about Lifetime ISAs and pensions:
How is the LISA taxed versus a pension?
LISAs and pensions are really the reverse of each other in terms of tax: with a pension, you pay tax on the way out not on the way in, while with a LISA the opposite is true. So, you get tax relief on what you pay into your pension (up to the highest rate of income tax you pay), but you must pay tax on anything you later withdraw above the first 25%. With a LISA, you don’t get tax relief on money you pay in, but everything you withdraw is tax-free. A LISA is subject to inheritance tax, but a pension is not.
How flexible is a pension compared to a Lifetime ISA?
Pensions are not terribly flexible, but then they are not meant to be while you’re in the ‘accumulation phase’, meaning you’re paying in not taking out. Once you’ve put money into a pension, you can’t touch it until you reach the age of 55. At that point, you have a lot of options as to what to do with your pot, thanks to pension freedoms. If you wanted, you could withdraw the lot in cash and go on a shopping spree (don’t do this). There’s no longer a requirement to buy an annuity, you can go down many different routes to make your pension cash work hard for you once you stop working. More on this is our guide 'What is pension drawdown and how does it work?'
You can transfer your pension to another provider before the age of 55, and you can merge more than one pot together if you want to consolidate and simplify your pension savings. You can also change the investment mix within a pension - certainly, you or your adviser should review your portfolio at least once a year and make tweaks if needed. If you haven't yet got a financial adviser, then read our article '10 tips on how to find a good financial adviser'.
The LISA is perhaps more flexible because it can be used for two purposes: to buy your first home, and/or to save for retirement, or both. You can withdraw your savings in an emergency, although you would pay a hefty penalty to do so of 25% of the amount you withdraw. This means not only will the government claw back its bonus, but you will also lose some of your own money and interest earned on it. So, if you treat your LISA as a cash machine, you could get back less than you put in. You also pay the same charge if you transfer your LISA money into another type of ISA. Most platforms will make it easy for you to change the investment mix in your stocks and shares Lifetime ISA.
Is a Lifetime ISA better than a pension?
The LISA wasn’t designed to replace a pension, the government intended it as a complementary savings vehicle which would sit alongside. For most people, a workplace pension will be better than a LISA because you get the benefit of your employer paying in, and this will usually outweigh the 25% bonus you get on a LISA. But if you aren’t in a workplace pension, a LISA could be a useful way to save for retirement with some extra support from the government. Remember that you can pay a lot more in to a pension than you can into a LISA each year, so relying on the LISA alone might not be enough to get you a decent retirement savings pot
Can I have a Lifetime ISA and a pension?
Yes you can. If you’ve maxed out contributions into your pension, a Lifetime ISA could be a valuable addition to your portfolio.
Lifetime ISA explained
The Lifetime ISA replaced the Help to Buy ISA, which was designed to help savers onto the property ladder. There are two types of Lifetime ISA available: a cash version and a stocks and shares version. The former allows you to save just in cash, like a normal savings account, and earn interest, while the latter lets you invest in funds or stocks, and you can hold cash in these too. The maximum bonus you could earn with a LISA is £33,000, if you invested from age 18 to age 50. Read our detailed guide 'Lifetime ISAs explained - are they a good way to save?'
Is a Lifetime ISA right for you?
Below we detail the main pros and cons of getting a Lifetime ISA.
Lifetime ISA pros
- It’s more flexible than a pension in that you can use it to buy a first home and/or for retirement savings, and you can access your money early if you’re willing to take a 25% hit.
- The bonus is now paid monthly (formerly annually), meaning it has more time to earn interest.
- All proceeds are tax-free.
- They are easy to open with low minimum contributions.
- You can choose to hold your money in a LISA in cash (useful if you might soon use it to buy a house, or you are risk-averse) or to invest it.
Lifetime ISA cons
- You can only save up to £4,000 a year.
- Contributions are made from post-tax income.
- You have to be under 40 to open one, although you can keep paying in and getting the bonus until age 50.
- You can’t touch the money without a withdrawal penalty until you either buy your first home, you reach age 60, or you become terminally ill.
- If you choose to invest through a LISA, your money is at risk in the stock market.
- You might not know what sort of investments you should hold in your stocks and shares LISA, and your provider may not offer a wide choice.
- You’ll pay fees and charges to your LISA provider.
- The LISA is subject to inheritance tax.
- It could affect certain means-tested benefits.
- It could be used to pay your creditors if you went bankrupt.
- Future governments could choose to change or withdraw the LISA, so it could be risky to treat it as your only long-term savings vehicle.
A pension is best for someone who is employed because they can benefit from employer contributions to their retirement savings, as well as tax relief on their own contributions.
There are quite a few different types of pension available, such as a workplace pension scheme, a SIPP (self-invested personal pension) that you manage yourself, a stakeholder pension, or a personal pension managed on your behalf by an investment platform or a digital wealth manager, for example.
Some workplaces will offer defined benefit pensions (such as final salary schemes) but most will now be defined contribution, where your total pot on retirement is linked to what you paid in and how it performed, not what your salary was with that employer. To learn more about pensions, read our guides such as 'How to start paying into a pension' or 'How to set up a pension - Everything you need to know'.
Is a pension right for you?
Below we detail the main pros and cons of getting a pension.
- By law, if you are eligible for auto-enrolment, your employer has to enrol you into its workplace pension scheme and contribute to your pension. This is a hugely important benefit as it can be very valuable over the years, and some employers pay in more than the minimum contribution required or match or exceed your contributions, so check what your employer’s policy is.
- The government also contributes by giving you tax relief on whatever you pay in, so in effect you get a double whammy of free cash when you contribute to a workplace pension.
- You can get a DIY pension such as a SIPP which will allow you to choose your own provider and will usually give you a much wider investment choice and complete control over your pot.
- You can use pensions for tax planning because they don’t form part of your estate for inheritance tax purposes.
- Pensions don’t affect benefits.
- They can’t be used to pay creditors if you go bankrupt.
- Contributions are capped at £40,000 a year.
- You can’t touch the money until age 55 (although this could be a pro in the sense that you know you can’t fritter that money away).
- Withdrawals are subject to income tax (up to 25% can be taken tax-free)
- Your money is at risk in the stock market. Given the painful falls in global markets recently, people nearing retirement will have seen some of the value of their pension pots wiped out, with little time left to rebuild them.
- You will have to pay fees and charges to your pension provider (and financial adviser if one manages your pension for you), and the industry is not great at making these transparent and easy to understand and compare, so you might not always know if your charges are competitive.
- Some types of pension may have a limited investment choice and may put your money by default into underperforming funds. If you don’t know much about funds, it could be hard to decide what you should be investing in and research or expert help may be required.
Pension vs LISA if you’re employed
Whether you are a higher-rate or lower-rate taxpayer, a pension will usually be your best bet if you are employed and your company pays into a pension on your behalf. You’ll get tax relief on your contributions at the highest rate of tax you pay. So for example, if you’re a basic-rate taxpayer, for every £80 you put in the pot, the government adds £20.
Pension vs LISA if you’re self-employed
Higher-rate taxpayers who are self-employed will usually benefit more from a pension than lower self-employed earners. That’s because the 40% tax relief is higher than the 25% LISA bonus. But if you are self-employed and pay basic-rate tax, you might need to weigh your options more carefully, and you might think it’s worth having both a self-administered pension and a LISA to save for retirement. Find out which is the best pension if you’re self-employed with our guide.
The best Lifetime ISA providers
It took a while for providers to get on board and start offering Lifetime ISAs, but now there is a decent range of products to choose from. Our three picks at the moment are Nutmeg, Hargreaves Lansdown* and Moneybox. Find out why in our detailed guide to the best and cheapest LISAs.
The best pension providers
If you’re looking to set up your own pension, a SIPP could be a good option. There are many to choose from. Heavy hitter Vanguard recently entered the SIPP market, shaking it up with a low-cost offering which is certainly worth a look, check out our Vanguard SIPP review. Alternatively, Interactive Investor* can be cheaper depending on how much you intend to invest and is currently waiving its SIPP fee for 6 months (meaning investors can save £60 when they open a SIPP). Check out our independent Interactive Investor review. And here’s our look at the best and cheapest SIPPs on the market.
Should you save into both a pension and a LISA?
If you’re a self-employed basic-rate taxpayer and you can put away more than the annual LISA limit, you should probably have a SIPP as well. If you’re employed, it makes sense to maximise what you can get from your workplace pension first, but if you’re lucky enough to be able to pay into your pension up to the annual allowance, a LISA could help you make the most of whatever else you can save.
For most people who are employed, a workplace pension will be the best option because your employer pays in and you also get tax relief, but you still might want a LISA to help you save to buy your first property. If you’re self-employed, higher-rate taxpayers will probably be better off in a pension, while basic-rate taxpayers who can’t save more than £4,000 a year might be better in a LISA.
If a link has an * beside it this means that it is an affiliated link. If you go via the link Money to the Masses may receive a small fee which helps keep Money to the Masses free to use. The following link can be used if you do not wish to help Money to the Masses or take advantage of any exclusive offers - Hargreaves Lansdown, Interactive Investor
Looking for a financial adviser near you?
Do you need financial advice? An independent financial adviser can show you how to make the most
of your money. Find your nearest qualified and regulated adviser using this VouchedFor search tool.