ISA vs LISA vs pension

ISA vs Pension

ISAs and pensions have their own advantages/drawbacks. More detailed analysis can be found on this Monevator article, but in summary:

Please Note: The limit is £20,000 (18/19) per year in either Cash, Stocks & Shares, or a combination of both. You can only subscribe to one cash ISA and one Stocks & Shares ISA per tax year, but you can transfer previous years’ ISAs to anywhere. In ISA terminology new money paid in is a “subscription”.

Example: Mr I N Vestor pays £100 into a Cash ISA and £100 into a Stocks & Shares ISA on 6th April (start of the new tax year). He cannot open any other ISAs this year, and has made a total subscription of £200. He could pay the remaining £19,800 into either plan or a combination of both. He could transfer last year’s ISA into either one of his current plans, or any other different plan, without penalty, as long as no further subscription is made to the other plan.

Cash ISAs can be useful, but in the current low-interest environment the overall tax benefits of Stocks & Shares ISAs are better for most people most of the time. Especially considering that some current accounts pay double the best current Cash ISA rates

TreatmentStocks & Shares ISAPension
Annual limit£20,000Lower of £40,000 or annual salary, unless net adjusted earnings exceed £150,000, when it tapers down to £10,000 *
Lifetime limitNone£1.03 million (planned to rise with inflation) *
Tax relief on contributionsnonehighest marginal rate (20%, 40%, 45%) up to annual limit *
Tax treatment of funds withinTax-free growth (no CGT) and tax-free income (through dividends)Same as ISA
Tax treatment on funds taken outtax-free25% tax free, remainder subject to income tax as earned income
When the funds can be taken outAny timeAfter age 55 (due to rise to be 10 years before state pension age)
Death treatmentCan’t be inherited in-situ, forms part of deceased estatePayable 100% tax free outside of estate if death before 75, liable to income tax on recipient if death after 75 *
*The treatment is actually far more complicated, but for most people this is correct.

As you can see, there are pros and cons to both. From a purely financial point of view, for most people pensions will be better, but ISAs have some key advantages:

  • No lifetime limit
  • Funds can be accessed at any time
  • Less risk of regular goalpost moving (pension reforms are often a key promise made by political parties to win elections).

It is generally agreed that whilst pensions should be prioritised, it doesn’t hurt to have some savings in ISAs too.

Lifetime ISA vs. Pensions

The chief advantages of pensions are tax relief, employer matching, and treatment of the funds on death

Tax Relief

If you are a higher rate taxpayer, your tax relief is at 40%, so if you take £600 of take home pay and put it in your pension, your pension will go up by £1000. If you paid that same £600 in to a LISA then you get a 25% bonus on it and it will be worth £750. The pension is better value.

Even if you are a basic rate tax payer, if you pay in to your pension via ‘salary sacrifice’, you will avoid National Insurance Contributions of 12% on pension contributions in addition to the 20% tax relief, so again you end up ahead.

If you don’t or can’t use salary sacrifice, a pension is likely to be better value as long as your employer offers some contribution matching, this is essentially free money/extra salary which can only be gained by saving it in to a pension.

Access timing, taxation and limits

In general you may be able to access your pension from aged 55 (although this is intended to rise to state-pension-age-minus-ten-years) rather than aged 60 in a LISA.

Pension withdrawals are generally 25% tax-free and 75% taxable as income. LISA withdrawals are completely tax-free once aged 60.

There is an annual contribution limit of £4,000 with a LISA (before the “bonus”) and £40,000 for a pension. There are no lifetime limits on LISAs, abut there is a “Lifetime Allowance” for pensions (which is currently in excess of £1M).

Benefit assessments

LISA holdings would be considered when assessing benefit applications. This could be an issue if you were out of work having used a LISA to save for retirement. Pension holdings are not assessed unless available, and even then are assessed as income only.

Treatment on death

LISAs are treated as estate assets on death, and could be liable to inheritance tax. They would also need to be liquidated and passed on as cash.

Pensions have very attractive treatment on death, with no tax payable by the recipient whatsoever if death occurs before age 75, and taxed as income on the recipient after 75. Pension benefits are not ordinareily included in estate assets and so shouldn’t attract inheritance tax.

Comparison table

Lifetime ISAPension
Available from6 April 2017.Now.
Age you can open18 to 40.Any age.
Annual savings limitMaximum £4,000 per year.Maximum £40,000 per year, with the potential to “carry forward” unused allowance for up to three previous years. Personal contributions are capped at your earned income for the year, though those with no earnings can contribute £3,600 (gross of 20% tax relief). Tapering of annual allowance as low as £10,000 pa for those with Adjusted Income above £150,000, and Threshold Income above £110,000. Money purchase annual allowance of £10,000 if benefits have been flexibly accessed.
Upper age limit for paying inContributions up to the age of 50 will qualify for bonus. No upper age limit but no bonus paid /accrued post the age of 50.Generally 75 years old, although employer and employee can continue to contribute but without tax relief.
Lifetime savings limitNo upper limit.£1 million (the lifetime allowance) including contributions/accrual and investment growth, unless the individual has a higher lifetime allowance.
Government contribution25% bonus (max £1,000 per year) paid at the end of the tax year. Effectively 20% flat rate relief.20% tax relief automatically paid on personal contributions. Higher rate and additional rate relief can be claimed separately up to the 100% of earnings, up to the standard annual allowance, tapered annual allowance or money purchase annual allowance.
Employer contributionNone, though employer could probably pay in directly provided the payment was treated as a “relevant payment” for tax and NIC purposes. Alternatively, additional salary could be paid to assist the investor’s contributions.Can be paid for employees to a registered pension scheme. An employee and employer contribution is mandatory under automatic enrolment provisions.
Impact on ISA contribution limitPayments reduce amount that can be paid to other ISAs ie. the overall limit for all ISAs (including LISA) is £20,000 for 2017/18.Pension contributions have no impact on ISA saving limits.
Investment optionsEither cash or stocks and shares.Wide range of investment choice usually available.
Borrowing from the fundMay be possible to borrow a limited amount from LISA without a charge, provided it’s fully repaid within a specified time. This is likely to be considered through consultation.Generally not possible to borrow from pension, other than in limited circumstances.
Tax on investment growthNone.None, as long as the total funds are within the lifetime allowance.
Age you can access fundsAny time, but to avoid a clawback of the government bonus, plus growth and a 5% charge, any withdrawal before the age of 60 must be to fund a first home purchase up to £450,000 or on terminal illness.Usually age 55. This is proposed to change to state retirement age minus 10 years. If life expectancy is less than 12 months withdrawal is possible at any age
Early access penaltyReturn of the government bonus, interest growth on that bonus, and a 5% charge on that sum. There may also be provider charges on exit.Pension benefits paid before the age of 55 will be subject to an unauthorised payment charge of up to 55%. In reality early withdrawals are just not possible.
Position on deathSubject to IHT (except to the extent invested in BPR qualifying shares) but no further tax charges. Spouse can inherit value of a LISA as additional subscription allowance.Free of IHT as long as Trustees have discretion to choose beneficiary (this is the case the vast majority of the time). Likely to have an income tax charge on benefits paid following death of a member age 75 or older.
Taxation on withdrawalsTax-free withdrawals as long as funds are used to purchase a property or the investor is over 60 years old.25% of fund is available as a tax-free “Pension Commencement Lump Sum”, the remaining 75% taxed on withdrawal as earned income, though no NI is payable.