Ever since they were announced in the Budget, Lifetime ISAs have been causing a stir. These new accounts offer big bonuses to anyone saving for retirement, but should you be choosing a Lifetime ISA over a traditional pension?
The obvious appeal is those three letters at the end. Nearly 20 years of ISAs mean they are a familiar savings vehicle for most of us, whereas many people find pensions complex and daunting.
With a Lifetime ISA, you pay in taxed cash which then grows tax-free. If you leave it alone until your 60th birthday, the government will give you a 25 per cent bonus. The money also won't be taxed when you withdraw it.
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Its simplicity may be appealing, but it will cost you if you are a higher or additional rate taxpayer. With a pension, when you pay money in, the government immediately adds 20 per cent to make up for the income tax you paid on your contribution. If you are a higher or additional-rate taxpayer, you can reclaim that extra tax you paid, too. That means, to make a £100 contribution, a basic-rate taxpayer only needs to pay in £80, a higher-rate taxpayer £60 and an additional-rate taxpayer £55.
Also, opting for a Lifetime ISA instead of a pension would mean you miss out on employer contributions. New rules mean businesses must make payments into their employees' workplace pensions. Opt out and you are effectively turning down free money.
"The Lifetime ISA makes sense for somebody who is trying to save for their first home but not someone to opt out of a workplace pension, where the most powerful benefit of the workplace pension is the employer contribution," says pensions minister Baroness Altmann.
It is also worth noting that the 25 per cent bonus isn't quite as generous as it first seems. The most you can save each year is £4,000 and money saved after you turn 50 won't qualify for the government's extra. So, you could earn up to £1,000 a year up until your 50th birthday but after that, your only growth will be via interest or stock market growth.
That deposit limit means you would struggle to save enough to cover the costs of retirement. Over 20 years, assuming a 3 per cent growth rate, you would build a maximum £116,000 nest egg, plus a £10,000 government top-up. That would provide you with an annual income in retirement of less than £6,000, according to Fidelity International’s calculations.
A Lifetime ISA is easier to understand than a pension but make no mistake, you pay for that with less generous tax relief, no employer contributions and a deposit cap that will stifle your ability to save enough for retirement.
