Planning for retirement is something that needs to be considered carefully because after all, your life depends on it. But most people find it confusing especially when it comes to weighing up a SIPP vs LISA.
There are numerous different savings accounts available for those looking to put away money and save for retirement but how do you know which one will suit you best?
Not every account is designed the same and they all come with varying benefits, so it’s important to do plenty of research before settling.
With the recent introduction of the Lifetime ISA (LISA), the whole debate about whether to save and invest for retirement via a Self Invested Pension Plan (SIPP) or LISA has erupted again.
The main proponents for SIPPS say that it 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.
However, here we look solely at the benefits of saving for retirement using a SIPP vs LISA.
First, in order to see which of these two tax shelters is better for you, you need to understand how they differ.
What is a SIPP?
A SIPP stands for Self Invested Personal Pension Plan. It is a type of pension plan that is most commonly used by more experienced individuals that like to manage their own investments. The benefit of a SIPP is you retain complete control over how you invest your money and they also offer a wide range of different investments. You can open a SIPP via a wide range of different providers such as Interactive Brokers, Saxo Bank and Moneyfarm.
What is a LISA?
A LISA stands for Lifetime ISA. It’s like a normal ISA but is specifically designed to save towards your first home or retirement. A Lifetime ISA can be either cash-based or Stocks and Shares. Lifetime ISA LISA benefits from 25% tax relief on contributions received. Investment growth in the LISA is completely tax-free and so are withdrawals. Certain restrictions however apply so they are not as flexible as a traditional Stocks and Shares ISA. There are limited providers that offer the Lifetime ISA but if you are looking at investing in stocks and shares, Interactive Brokers, Saxo Bank and MoneyfarmMoneyFarm are your best bets.
The three main distinctions between a SIPP and a LISA are the amount of tax relief you receive, the age you can start to withdraw your money and whether your money is taxed on the way out.
Let’s look at the features of both tax shelters. Firstly, we will look at a SIPP:
How does a SIPP work?
- Tax relief on your contribution:
Government tops up your pension depending on your income tax band.
If you are a basic ratepayer, the government adds 20% to your pension pot. So if you put £800 in a SIPP, the government will add £200 to make it £1000.
If you are a higher ratepayer, the top-up is 40% so you only have to put £600 in a SIPP to get £1000.
If you are an additional ratepayer, the top-up is 45% so you need to put £550 in a SIPP to get £1000.
Read this article to find out more.
- Withdrawal age:
At present, you can start withdrawing money from a SIPP at age 55, this will be gradually increased to 58 by 2028.
You will be able to access your private pension or SIPP around 10 years prior to your state pension age.
You can check your state pension age, and amount, HERE.
- Tax consequences on withdrawal:
You can withdraw 25% of your pension pot as a tax-free lump sum once you reach the minimum retirement age. The remaining 75% you will be liable to income tax at your highest marginal rate.
Now on to the Lifetime ISA, features are:
How does a LISA work?
- Tax relief on your contribution:
Government tops up £1 for every £4 you put into a LISA. Essentially 25% tax relief.
So if you save £800 via a LISA, you will receive £200 making it up to £1000.
- Withdrawal age:
The age you can start withdrawing from your LISA is higher than a SIPP.
The current stated age is 60, some five years later based on the current minimum pension age of 55.
If you were a first-time buyer however and wanted to buy a house using funds in your LISA, you can withdraw your money for this purpose.
Please be aware there are restrictions on things like the value of the property you can buy so check here for more info.
You would also be able to access LISA funds without penalty before 60 if you become terminally ill and have less than 12 months to live, wahey!
- Tax consequences on withdrawal:
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 it’s 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 Lifetime 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 now concentrate on looking at which is the better option from a purely financial and investment standpoint.
SIPP VS LISA Tax relief?
Both a SIPP and a Lifetime ISA involve an element of tax-free money in the form of the government top-up.
Whilst the LISA has a flat rate contribution from the government of 25%, a SIPP has a contribution based on your income tax band (20%/40% or 45%).
Let’s look at an example to see how this works.
To be able to have £1,000 in your pot, you need to invest the following amounts:
- Basic rate 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 taxpayer.
In both cases, you need to contribute £800 of your own money to end up with £1,000
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 taxpayer, you are better off by £200 (as you only contribute £600 instead of £800)
If you are an additional rate taxpayer, you are better off by £250!
So if you 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 a LISA. Of course, the 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 individual’s highest rate of income tax.
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 also 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 advantageous 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. You need to pay income tax on the rest based on your income tax band the year in which you take the money.
With this in mind, let’s see if the LISA becomes more attractive than a SIPP.
- Saving £1,000 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 £1,000 pension contribution would cost £940.
- For a higher rate payers paying 40% income tax in working life and in retirement, a £1,000 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 £1,000. The cost increases if you are investing via a pension as you need to contribute £940 to receive £1,000 if you are a basic rate payer or £860 if 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 Lifetime ISA 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 influencer 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 taxpayer who will have taxable income in retirement, saving via a LISA should be more beneficial.
- If you are a higher rate taxpayer who 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.
SIPP vs LISA – Other Considerations
- Contribution Limits
With a Lifetime ISA, you can only contribute up to £4,000 a year (topped up to £5,000) and this will use up some of your £20,000 ISA allowance.
With a pension, you can contribute the higher of your relevant earnings or your annual allowance.
- Employer contributions
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 Lifetime ISA 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 or the tax relief you would receive.
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.
Please be aware this article is for entertainment purposes only, based on my opinions only and does not constitute financial advice. If you are still unsure what to do you should book yourself a review with a Financial Adviser regulated by the Financial Conduct Authority.