LISA - Lifetime ISA

Is a LISA right for you? Lifetime ISAs or ‘LISA’s have had a pretty bad rap since coming into existence in 2017. Here are some considerations and some great features that not many people are talking about.

What is a Lifetime ISA (LISA)?

A Lifetime ISA is a savings or investment wrapper that can be used for two main purposes:

  1. Retirement Fund – similar to a pension
  2. Help-to-buy your first property

For this article, we are going to cover the pension version of the LISA. The help-to-buy version is nearly always better than a standard ISA if you are saving to purchase your first home.

The BIG attraction of a LISA is the part where your money is topped up courtesy of the government by another 25%! Try to find any other account where you get a 25% return on your investment.

Of course, this sounds great but there is a catch; you cannot access the money until you are 60, well you can… but …. ok maybe LISAs are confusing.

What you need to know about Lifetime ISAs

  • You must be over 18 and under 40 to open a LISA
  • You can put up to £4,000 per year into a LISA
  • The government will add a 25% bonus up to £1,000 per year
  • You can put money in up until age 50
  • LISAs can be held in cash or investments – similar to an ISA
  • LISAs are designed to be withdrawn after 60
  • You can withdraw money before 60 but the Government will take back 25% of the amount withdrawn
  • Money taken out of a LISA is tax-free similar to an ISA (known as a tax-wrapper)
  • You can have both an ISA and a LISA on the go, but you can only contribute a total of £20,000 per financial year across the two

Understanding Tax

LISAs, ISAs and Pensions are products that can help you reduce how much you pay in tax, either now or in future. It is important to understand the tax on your payslip so you can make effective investment decisions. I know it’s boring but trust me, understanding the basic principles is important if you want to take control of your finances.

If you are a higher rate taxpayer (you earn over £50,000 as of April 2019), whatever you earn above this amount is taxed at 40%.

If you earn under £50,000, then you are taxed at 20%.

To add to the confusion, there is also your National Insurance contributions which are also deducted from your salary. If you are unsure about your takehome pay, we find this a really useful calculator.

And to understand more about your tax code, then check out this post.

LISAs vs Pension

LISAs are generally considered a bad investment versus a pension. If you contribute to a pension you get tax relief. Tax relief allows you to contribute to a pension out of your salary before any Tax and National Insurance are deducted (Gross Salary).

Putting money into an investment after you have been paid, usually means you have already paid Tax and National Insurance.

Therefore, tax relief allows you to put in much more, with less impact on your take-home pay.

How tax relief works on workplace pensions: If you are a standard rate taxpayer at 20%, for every £100 you earn, you get to keep £80. This is your take-home pay. For every £80 you contribute to a pension (from your takehome pay) the government applies tax relief and so you end up with £100 in your pension. It effectively means you pay no tax on money you contribute into a pension, you get the Gross amount.

That’s equivalent to a 25% bonus! For higher rate taxpayers at 40%, you only need to put in £60 to get £100 in your pension, meaning a 66% bonus.

Pensions are nearly always better than LISAs

Pensions also can also have additional benefits. For example, your employer may match your pension contributions.

As we now know, for a higher rate (40%) taxpayer, a £60 pension contribution will be topped up to £100 via tax relief. The employer then may match this contribution, therefore that £100 will be doubled to £200. Altogether, this is equivalent to a 333% return, instantly.

This is why personal finance advice 101 is to make sure at the very least you match your employer pension contributions. Not doing so means you are missing out on free money.

Some employers may also offer contributions via salary sacrifice, meaning even more money added!

LISA’s simply don’t come with these benefits.

So let’s be clear; adding to a pension over a LISA is nearly always better.

Accessibility

The one consideration though is around accessibility. You will not be able to access any of your pension money until at least 55, currently. If you are retiring after 2028, this age pushes back to 57. A LISA can be accessed at any time as long as you are happy to take a 25% haircut or 3 years later at age 60 without penalty.

But you have to ask yourself; is that worth missing out on those juicy Pension benefits that over time, will make a huge difference in the size of the pot of money becomes? Not for most.

If you have maxed out your annual pension contributions (currently £40,000 per year) or have hit your Lifetime Pension Allowance (currently just over £1 Million), then a LISA can provide an additional tax shelter for your pension monies.

LISA vs ISA

This is a harder one compared to pensions.

If you are contributing to an ISA, then you are doing so from your take-home pay (Net Income). So any tax, national insurance and deductions have already been taken out of your salary. Crucially, you do not get that lovely tax relief.

If you were to change your ISA investment into a LISA, then you would get 25% added by the Government to each of your contributions.

Remember, these are just tax wrappers. You could use your LISA to invest in the stock market or keep it as cash – the same as your ISA.

If you wanted to take money out of your LISA, then you are hit by a deduction of 25%. This might feel like you are back to the same place as the ISA but the math doesn’t quite work out like that. In fact, it’s worse – see the example below.

The price of flexibility

Mr ESM puts £4,000 into his LISA in year 1 and the Government adds 25%, meaning his pot is now £5,000. He then changes his mind and wants to withdraw the money. £5,000 minus 25% equals £3,750! Mr ESM is upset as he has lost around 6% (or £250) from his initial deposit. This is the price of flexibility.

Yes, it might feel bad to lose some of your initial deposit. This is a way to stash money away for your retirement but also have the flexibility to access that money in an emergency. You don’t get that option with a pension.

You can also make partial withdrawals if you do not need all the money at once but of course you will lose 25% of anything you take out.

Do these before starting a LISA

  • Higher rate taxpayers should always consider pension top-up first.
  • Any employee not getting the full pension match from their employer should absolutely consider upping their pension contributions first to at least equal the match.

Tax implications (and leveraging them)

Withdrawing money from a pension is treated as personal income and taxed accordingly. If you take more then £12,500 (personal tax-free allowance for 2019/2020), you will have to pay Income Tax. The tax you pay will depend on how much you withdraw each year, exactly like PAYE.

Because ISAs and LISAs are tax-wrappers, money withdrawn is not subject to the same tax. You can withdraw as much as you like from your ISA or LISA without paying any income tax. Contributions into ISAs and LISAs are seen as already taxed because funds are paid in from net income (income after tax).

This opens up some interesting options when considering how to minimise the tax you pay at pension age. If you could keep your state and personal pension withdrawals below the income tax threshold and then top up that income with ISA and LISA withdrawals you could effectively pay no income tax in retirement!

LISAs – the small print

  • You can hold more than one LISA but you can only contribute to one per financial year (same as ISAs)
  • You can move to another LISA provider at any time
  • All money taken out of a LISA after 60 is tax-free
  • You don’t have to take all the money out at once
  • LISA savings will affect your ability to claim means-tested benefits (Pensions don’t!)

Can LISA rules change?

Yes, any current or future Governments can change their mind on LISAs. They could retire the product which might allow you to migrate your money (and bonuses) to another product or they could stop adding the top ups.

This is no different from any other Government defined investment like Pensions and ISAs.

ISA rules have changed in the past by allowing you to contribute more each year. Pension rules have changed meaning you might not be able to get full access to your pension until an older age threshold.

This is just the way things are. Don’t like it? Get in to politics.

The good news is, that here at Eat.Sleep.Money we will aim to bring you the latest updates and remind you when you might need to consider changes.

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LISA (Lifetime ISA): Better than an ISA or Pension?
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