I would like to ask your brain about the pros and cons of the Lifetime Isa compared to a personal pension.
To give you some context, I recently switched an old private company pension fund to a private moneybox pension for more control over my investment.
I also moved money into Nha Trang Lifetime which I wanted to open before turning 40 to protect my bets.
I have an Isa stock and shares and have a relatively diversified personal stock and stock account. I am also paying the highest I can get into my employer’s pension scheme.
Decisive: Our readers are wondering whether to save more into Nha Trang Lifetime or a pension
My question is; should i pay more into my Lifetime Isa over the next 13 years (until 50) to get it at 60 with no tax when i withdraw or continue to pay more into my private pension with hope that money will accumulate over time?
Obviously, I’ll be paying 20% tax on the back end with this income, so wondering if the less volatile LLifetime Isa option would be more profitable?
I know both have their pros and cons so I’d love to hear your opinions. I also own my own home so I won’t need to use Lifetime Isa for this, but it could be a great way to save for my kids’ future. Any advice would be most welcome.
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Steve Webb replied: When Isa Lifetime was introduced, it had two purposes – to help first-time buyers accumulate deposits and to allow people to save for their retirement.
In your case, it is the long-term role of an Isa in providing later-life finance that interests you most.
As you specifically asked about the tax difference between saving in Isa Lifetime and saving in a pension, I will focus my answer on that.
However, as a reminder to other readers, some other factors to keep in mind when comparing the Isa to a pension would be:
– Your employer must pay a minimum amount into your pension and may even pay more if you contribute more; this is a very strong advantage of pension compared to Isas / Lifetime Isas;
– Different types of products have different fees; many workplace pensions have very low fees, especially if you work for a large company, so a workplace pension can be cheaper as an investment vehicle than stocks and shares Lifetime Isa / Isa;
– Accessibility – you can now access retirement money from age 55, although this will increase to 57 by 2028 and could increase further; funds in Isa Lifetime are locked until you turn 60 (unless you’re willing to pay a penalty).
Regarding the tax treatment of Pensions and Lifetime pensions, the key differences are:
– Together For Life, you contribute from your take-home pay but the Government gives you a top-up; for every £4 you invest (up to a maximum contribution of £4,000 per year), the Government will add £1 (i.e. a maximum of £1,000); there is no tax on your Lifetime Nha Trang investments, and any withdrawals once you reach the age of sixty are fully tax-free;
– With a pension, you get a tax break on your contributions up to an annual allowance of £40,000 (for most people); the higher your tax rate, the more tax relief you get on pension contributions; the money inside the pension is tax-free; When you come to collect your money, a quarter can be tax free and the rest taxed when you withdraw it, along with the rest of your earnings. There is also a lifetime allowance that limits the amount of pension you can accumulate while continuing to receive tax relief.
If we focus exclusively on the tax difference between the two, the balance between Lisa and pension depends on whether you are paying basic or higher taxes while working, and including your tax position in retirement.
To simplify things, we will now assume that investment growth and fees are the same whether you own shares and share a Lifetime Isa or a pension, and that there is no add the employer’s contribution to the pension.
We also assume that you don’t have an Annual or Lifetime Allowance problem.
The easiest way to see the difference is to consider two people, each with the option of paying into each other for life or a pension, one of whom currently pays taxes at the base rate and the other at a higher rate.
Taxpayers at the basic rate
Starting with the basic rate taxpayer, let’s assume they contribute £80 to Nha Trang for life.
The government will pay this up to £100. Ignoring profits and investment fees, this would be £100 in retirement and possibly tax free. So the one taking out Lifetime Isa starts with £80 and ends with £100.
Now suppose the base rate taxpayer pays instead into a pension, and is also a base rate taxpayer in retirement.
If the worker pays £80 into a pension from his after-tax earnings, the government will address the issue with a base rate tax break to generate £100 of the pension. In retirement, a quarter (£25) can be tax-free, but 20% tax is payable on the remaining £75. This is £15 in tax, with £85 remaining after tax.
In this simple example, both people put £80 on their product but the person with Lisa gets £100 in retirement while the person with a pension gets £85. Both are good investments, but if you look purely at taxes, then Isa Lifetime seems to be better.
Now consider who is a higher rate taxpayer while working but a base rate taxpayer in retirement.
The calculation for the investment in Isa Lifetime remains the same as before. They put in £80 from their after-tax income, which is raised by the Government to £100 and they can get £100 tax-free in retirement.
But for pensions it is different. When workers pay £80 from their take-home pay into their pension, they still get an additional £20 top-up by HMRC.
But they can claim a tax break higher than £20 through their tax return. This means they spent £60 on a home to get their £100 pension.
In retirement, a quarter are tax-free, and the remainder taxed at the base rate, again leaving them with £85.
In this case, pension savers had a better deal. Savers for Isa Lifetime spent £80 to get £100 in retirement, a 25% increase. But pension savers spent £60 to get £85 – an increase of more than 41 per cent.
STEVE WEBB ANSWERS YOUR PENSION QUESTIONS
In summary, if you ignore the other differences and just focus on the tax treatment, a Lifetime Isa is nicer for a basic taxpayer than a pension, but a pension is nicer if you are taxpayer at a higher rate at work, provided you are a basic rate taxpayer in retirement.
Note that the examples assume a constant income tax rate. If interest rates fall over the time funds are drawn, that tilts the balance more towards the pension outcome.
One final thought on return on investment.
In principle, both stocks and shares of LLifetime Isas and pensions can be invested in the same type of investment, so unless there is a big difference in product fees or the type of funds available, it can’t be. doesn’t make much of a difference you choose as an investment vehicle.
However, you mentioned the ‘less volatile’ Lifetime Isa option which makes me wonder if you have a cash Lifetime Isa? If so, this is not a good idea in the long run.
If you’re currently under 40 and won’t touch money until you’re sixty, this means locking your money into an account that is offering very low interest rates and below the inflation rate. You are making guaranteed losses in real terms year after year.
While there is a role for Isa Lifetime cash for the short-term purpose of saving for a deposit, they are not really suitable in most cases for long-term savings.
If you compare a cash Isa to a workplace pension and look at it over a decade period, a higher return on investment in a workplace pension default is likely to be higher than offset. Get the tax advantage of your Isa Lifetime cash.
Ask Steve Webb a question about pensions
Former Pensions Secretary Steve Webb is the Uncle of This Is Money’s Agony.
He’s available to answer your questions, whether you’re still saving, in the process of stopping your job, or getting your finances in order for retirement.
Steve left the Department for Work and Pensions after the May 2015 election. He is now a partner at the consulting and monitoring firm Lane Clark & Peacock.
If you would like to ask Steve a question about pensions, please email him at [email protected].
Steve will do his best to reply to your message in an upcoming column, but he won’t be able to reply to everyone or respond privately to readers. Nothing in his answers constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.
Please include a daytime contact number with your message – this number will be kept confidential and not used for marketing purposes.
If Steve is unable to answer your question, you can also contact MoneyHelper, a Government-backed organization that provides free pension assistance to the public. It can be found here and its number is 0800 011 3797.
Stevee received many inquiries about state pension projections and COPE – Contractual Retirement Equivalence. If you write to Steve about this topic, he will answer a typical reader question here. It includes links to some of Steve’s earlier columns on state pension projections and contracting, which may be helpful.