With the recent introduction of the Lifetime ISA (LISA), the whole debate about whether to save and invest for retirement via a typical pension plan (SIPP) or LISA has erupted again. The main proponents for SIPPS say that is allows you to withdraw your money at an earlier age and it is particularly beneficial in a financial sense for higher and additional rate taxpayers. Advocates of the LISA on the other hand say that it offers more flexibility as it can be used to fund a property purchase and it also makes more financial sense for a basic rate taxpayer to save their money using this.
Here, we look solely at the benefits of saving for retirement using a SIPP and a LISA. In order to see which of these two tax shelters is better for you, you need to understand how they differ.
The three main distinctions between a SIPP and a LISA is the amount of government top up your receive, the age you can start to withdraw your money and whether your money is taxed on the way out.
Lets look at the features of both tax shelters. Firstly, we look at a SIPP:
- The Top Up on your contribution: Government tops up your pension depending on your income tax band. If you are a basic rate payer, government adds 20% to your pension pot. So if you put £800 in a SIPP, the government will add £200 to make it £1000. Read this article to find out more. If you are higher rate payer, the top up is 40% so you only have to put £600 in a SIPP to get £1000. If you are an additional rate payer, the top up is 45% so you need to put £550 in a SIPP to get £1000.
- Withdrawal Age: You can start withdrawing your money at the stated age, currently 55 but this increases to 57 from 2028?
- Tax consequences of Withdrawing Money: You can withdraw 25% of your pot as a tax free lump sum. You pay income tax on the rest of the money you withdraw based on your income tax band.
For a Lifetime ISA, the features are:
- The Top Up on your contribution: Government tops up £1 for every £4 you put into a LISA. So if you save £800 via a Lisa, government will add £200 to make it £1000
- Withdrawal Age:The age you can start withdrawing your LISA is higher than a SIPP. The current stated age is 60. (If you were to buy a house using funds in your LISA, you can withdraw your money anytime. See this article (LINK) ).
- Tax consequences of withdrawing money: The whole amount can be withdrawn tax free from a LISA.
The first aspect to note is that the age you can take money from your pension is currently lower than from a Lifetime ISA. So if you are looking to retire earlier rather than later, it is probably wiser to invest via a Pension as you can withdraw your money at an earlier age. But is is important to note that the pension age is always in the spotlight of politics and thus keeps changing and being pushed back.If you are currently in your early twenties, the Life time ISA could prove to be a quicker way to access your money. Who knows?
I think that when the question of investing via a SIPP or LISA gets thrown around, people are more worried about the financial consequences as opposed to the withdrawal age. Thus I will concentrate at looking at which is the better option from a pure financial and investment standpoint.
Does a SIPP or LISA give you more free money?
Both a SIPP and a Lifetime Isa involve an element of free money in the form of the government top-up. Whilst the LISA has a flat rate contribution from the government, a SIPP has a contribution based on your income tax band. Let’s look at an example to see how this works.
To be able to have £1000 in your pot, you need to invest the following amounts:
- Basic payer in a SIPP: £800
- Higher Rate payer in a SIPP: £600
- Additional rate payer in a SIPP: £550
- Basic payer in a LISA: £800
- Higher Rate payer in a LISA: £800
- Additional rate payer in a LISA: £800
The above shows that there is no difference to investing in a SIPP or a LISA if you are a basic rate tax payer. In both cases, you need to contribute £800 of your own money to end up with £1000
On the other hand, it makes much more sense to invest in a SIPP if you are a higher rate or additional rate taxpayer due to the higher tax reliefs you get. If you are a higher rate tax payer, you are better off by £200 (as you only contribute £600 instead of £800) and if you are an additional rate payer, you are better off by £250.
So if you are going to have No Taxable Income in retirement:
- If you are currently a basic rate payer – There is no financial difference between investing in a SIPP Vs a LISA
- If you are a higher or additional rate payer – Investing via a SIPP is better as you need less money to reach your target.
The above example is very simplistic in nature and aims to give an overview of the financial consequences of saving via a SIPP VS Saving via a LISA. Of course reality is not this simple as we need to incorporate taxes on withdrawals. Whilst LISA withdrawals are tax free, withdrawals on pensions above the 25% lump sum amount are taxed at the individuals income tax rate. This tax on withdrawals imposed on a pension alters the benefits of investing in a SIPP.
When making a decision to invest using SIPP or LISA, you need to take into account the withdrawal taxes as they can have a huge effect on the money you end up with. Let’s have a look to see which is the more advantage tax shelter when we take into account all taxes associated with both.
The LISA offers better returns when the taxes on withdrawing your money are factored in.
One of the best features of the Lifetime ISA is that all income can be withdrawn tax free once you reach 60. This is different to a pension (SIPP) where you can only take out a 25% lump sum tax free and you need to pay income tax on the rest based on your income tax band. With this in mind, let’s see is the LISA becomes more attractive than a SIPP.
- Saving £1000 in a LISA would still cost £800
Factoring in the 25% lump sum, these are the amounts you need to save in a pension in order to end up with £100.
- For basic rate payers paying 20% income tax in working life and in retirement, a £1000 pension
contribution would cost £940.
- For a higher rate payers paying 40% income tax in working life and in retirement,a £1000 pension contribution would cost £860.
When taking everything into account, it is clear to see that investing via a LISA is better as it only costs you £800 in order for you to receive £1000. The cost increases if you are investing via a pension as you need to contribute £940 to receive £1000 if you are a basic rate payer or £860 is you are a higher rate payer. This cost is attributable to the fact that you pay taxes at your income tax band when you withdraw money from your pension.
As you can see, the choice between investing via a SIPP or a LISA for your retirement can be a tricky one. There are benefits to both and the one that is most suitable for you will be determined by your personal circumstances. The main influencers of this is your taxable income now and in the future.
- If you are currently a basic rate taxpayer and will not have taxable income in retirement, saving via a SIPP or LISA should not make any difference to you.
- If you are currently a basic rate tax payer who will have taxable income in retirement, saving via a LISA should be more beneficial.
- If you are a higher rate taxpayer will not have taxable income in retirement, saving via a SIPP would be more beneficial to you.
- If you are a higher rate taxpayer who will have taxable income in retirement, using a LISA will be more beneficial to you.
Other things to consider
With a LISA, you can only contribute up to £4000 a year (topped up to £5000) and this will use up some of your £20000 ISA allowance. With a pension you can contribute up to the annual allowance.
Most employers contribute and offer ‘a match’ to your pension. This is essentially free money and if your employer does offer this, it is far more beneficial to invest via a pension. It will be interesting to see if employers offer any incentives to make LISA investing more attractive.
A lot of these decisions rely on the government not changing policy too much. However, the conditions of both these vehicles could change. For example, we know they can increase the age at which you gain access. It is my personal feeling that they are more likely to mess with pension policy than with ISA policy but you may have your own opinion.