Should you swap a pension for a Lisa?

Despite calls for a delay to the launch of lifetime individual savings accounts (Lisas), amid concern that providers don’t have enough time to design new products, the Savings Bill now winding its way through Parliament paves the way for their introduction in April 2017. And while the government is primarily pitching Lisas as extra help for people struggling to get on to the housing ladder, the accounts could also be an attractive way for many people to save more for retirement.

Lisas will be available to savers aged 18 to 40, as part of the general Isa allowance, which rises to £20,000 from April. You’ll be able to put up to £4,000 into a Lisa each year, with the government adding a top-up bonus of £1 for each £4 saved – or £1,000 if you save the maximum £4,000 over the year. The money can be invested in the same range of assets as other Isas, so can be used for long-term goals such as retirement planning. Still, compared to traditional private pension plans, which offer tax relief on contributions rather than a bonus, there are both pros and cons to Lisas as pension vehicles.

Tax is one issue to consider. Like private pensions, Lisas grow tax-free, but they also have the advantage of being tax-free when you cash them in, unlike pensions which are mostly taxable. In this context, a study produced earlier this year by the Institute for Fiscal Studies (IFS) looked at how much a saver would have to put into Lisas and private pensions to generate each £100 of savings. Crucially, the calculations accounted for both up-front tax relief and savings bonuses, and tax deducted at the end.

For a Lisa, the maths are simple. It costs £80 to generate £100 of savings, thanks to the 25% upfront bonus and the lack of tax to pay once the plan is accessed. For pensions the sums are more fiddly. Savers can only take 25% of their funds as tax-free cash in retirement, so on this basis, a basic-rate taxpayer today who remains on the basic rate in retirement would need £94 to generate £100-worth of savings after all taxes are taken into account. For a higher-rate taxpayer staying on the higher rate in retirement, the figure is £86. However for a higher-rate taxpayer moving to the basic rate in retirement, the figure comes down to £71.

So if you focus on tax alone, Lisas are a good bet compared with pensions, although there will be a sizeable number of higher-rate taxpayers who switch to the basic rate in retirement as their income comes down. But tax relief isn’t the only benefit of pensions. If you have access to a workplace pension, your employer will be required to make contributions. The same isn’t true of Lisas.

Also, the rules on maximum contributions to pensions are more generous. Most people are entitled to put up to £40,000 into a private pension each year, against the £4,000 Lisa limit. Even additional-rate taxpayers, who have smaller pension allowances, are entitled to save at least £10,000 a year.

There are other considerations as well. Lisas are designed to be accessed from age 60 onwards, unless you’re using the money to buy your first home, while pension savings are available from age 55. But Lisas can be accessed early if needed, albeit with high penalties, while pensions are off-limits other than in exceptional circumstances. Hence the choice is finely balanced – and the rules may change if they government keeps tinkering. Still, overall, Lisas look like a good supplement to pensions for many people, but not usually a replacement.