Should I save and invest in a LISA or Pension?

Last Updated on 17 March 2023 by Dan

Hello everyone! This post is inspired by talking to a friend the other day who had hit that moment of realization that they need to start saving for retirement, and was raising the question of if saving in a pension or a LISA (Lifetime ISA) was a better option for them. They were unclear on the differences between the two, so I thought I’d write a post to cover this in greater detail!

If you’re thinking about pensions in general, we’re a huge fan – and we’ve written a further guide on why you should save into your pension here.

Note for Scottish readers: In this article tax savings we make reference to are using figures based on tax values in England, Ireland and Wales. Whilst the same principle will apply for Scottish readers, note you have slight different tax bands to those stated here.

As ever – our normal note that we take care with what we write on this site but it is not official “financial advice” and whatever investments and savings you enter need to be right for your circumstances. We always suggest doing your own further research. If you’re in doubt about anything, it’s worth consulting a regulated and reputable financial advisor who can provide tailored advice built for you.

Unbiased is a resource that can help you match with an advisor who matches your needs.

What is a LISA? (Lifetime ISA)

A LISA (Lifetime ISA) is a scheme that let’s your save up to £4,000 a year either towards retirement or a first home purchase. In exchange for making this saving, the Government will top up your payment by a further £1,000, the equivalent of a 25% bonus.

It’s really important to note that if using your LISA to fund retirement, you cannot access any of the savings within until the age of 60. If you do, you’ll be charged 25% of the amount withdrawn.

This seems like you’re just losing the Government top-up, but actually the maths works in such a way you actually make a slight loss. As such, it’s really important to recognize that this is a long term investment.

You can have any funds kept within your LISA in the form of cash or investments. Any interest or investment growth is also tax free within the scheme (as per a regular ISA) which is a good extra bonus.

To open a LISA you have to be aged between 18 and 39, and can only make contributions to the LISA until you’re 50.

To note – as this article is covering saving for retirement, I’m not considering if a LISA is worth it for saving to be a first time buyer in this article.

What is a Pension?

(Please note: this article uses the term pension in relation to a defined contribution pension which the majority of people now have, rather than a final salary or defined benefit pension.)

A pension is a pot of money (usually held in the form of investments) which is designed to help cover your expenses in later life when you’re retired and no longer earning a regular salary.

In order to encourage saving into this structure, the Government provides various tax advantages – essentially saving the income tax you would have paid on the money you’re putting into your pension. You can save up to £60,000 a year into your pension (or 100% of your earnings) and receive tax relief, unless you’re a very high earner where this allowance becomes tapered (in official speak, it just means reduced!)

Unless you’ve opted-out of contributing to a pension, your company will also make an additional contribution to your pension, topping this up even further.

Most pension funds will have a minimum age you can start taking money from them without penalty – this can be as low as 55 but with the state pension age now rising, it’s becoming more common to see it be at least 57.

Cash from saving into a pension or LISA

Is it better to contribute to a Pension or a LISA first?

For most people, it will make sense to contribute to a pension first (unless you already have a lot of money in your pension where the lifetime allowance starts to be concern).

Owing to the tax save the argument is clearly in favour of “pension first” for a higher rate taxpayer. For a basic rate taxpayer the difference become much smaller – we think the extra year invested and potential NI save generally still just favours a pension.

Let’s break down the reasons:

A Pension can benefit from Matched Contributions

All companies will pay in a base level contribution to your pension, but some will also do a “matched top-up” where they will put in extra as long as you make a commitment. It’s an absolute no-brainer to do this and you should check if you’re taking advantage of any offerings your company has on it.

A matched contribution is like a 100% gain already! Over time, these can really add up.

A pension can give tax benefits

If you are a higher rate taxpayer, the tax saving on anything you put into your pension will be the equivalent of your income tax rate. The 40% benefit from this is is considerably higher than the 25% extra top up that you get from a LISA.

You may also save money on National Insurance contributions, which provides even more benefit.

A pension provides the ability to use salary sacrifice

If you pay tax by PAYE, most companies will allow you to “salary sacrifice” any money you put into your pension. This is highly efficient, as instead of paying income tax and then having it refunded, you simply never pay it in the first place and have longer to invest.

A pension starts generating immediate benefit.

This point is a little bit technical, but in the LISA the 25% bonus top up only kicks in at the end of the year, rather than when you make the deposit. With a pension, you get the tax saving right away – which means a whole extra year of the extra “benefit” being invested and saved.

Savings from investing into a Pension or LISA

Any questions?

The debate between Pension and LISA is in my opinion more confusing than it needs to be and I hope this article offers some insight into the differences between the two. If you have any questions we’d love to hear from you – just drop us a note in the comments below.

And that’s it!

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