LISA or pension for retirement saving?

A Lifetime ISA and a pension both get a government top-up, but they work in different ways and the money is locked up on different terms. A Lifetime ISA adds 25% to what you pay in, up to £1,000 a year, on contributions of up to £4,000 a year, and you can take the money out from age 60 or to buy a first home¹. A pension gives you tax relief on what you pay in, and if it is a workplace pension your employer adds money too³.

The choice matters most for people who have both options open to them. A Lifetime ISA can only be opened before your 40th birthday, and you can keep paying in and receiving the bonus until you are 50¹. A pension has no such age limit on opening, and a workplace pension usually comes with employer contributions of at least 3% of your qualifying earnings on top of your own money⁴.

The two are not simply rivals. A Lifetime ISA is designed for two things, buying a first home and retirement, and can be used for either or both⁵. A pension is built for retirement alone. What follows sets out how each one works, what each costs you if you need the money early, how they are taxed, and where the protections stop.

How a Lifetime ISA and a pension each work

A Lifetime ISA is a type of ISA, established from 6 April 2017⁹. The investments you can hold in it are the same as for a cash ISA or a stocks and shares ISA, so you can save in cash or invest in funds⁹. You pay in up to £4,000 a year, and the government adds a 25% bonus at the end of the tax year⁷. The money counts towards your overall ISA limit, and you pay no tax on the interest you earn¹⁰.

A pension works differently. You pay in from your earnings, and the government gives you tax relief on the contribution, which either reduces your tax bill or increases your pension fund⁵. In a workplace pension, your employer also adds money into the scheme for you, and in most cases must make contributions³. Your employer chooses the pension provider that invests the contributions¹².

The two products are treated differently for tax purposes, which is the source of most of the practical differences between them². A Lifetime ISA is a savings wrapper with a bonus attached. A pension is a retirement account with tax relief going in and income tax on much of the money coming out.

Government bonus or tax relief: how each one tops up your savings

The Lifetime ISA bonus is 25% of whatever you contribute, up to £1,000 a year, paid annually⁶. Pay in the full £4,000 and you get £1,000 from the government¹³. The bonus is paid at the end of the tax year⁷.

Pension tax relief works on a different principle. It is based on the highest rate of income tax you pay, and boosts your contributions by at least 20%¹⁴. For a basic-rate taxpayer, every £100 saved into a pension gets £25 added in tax relief¹³. That is the same rate as the Lifetime ISA bonus, and the two are equivalent for basic-rate taxpayers¹⁰.

The difference opens up for higher earners. Pension tax relief is worth more than the Lifetime ISA bonus for higher or additional rate taxpayers, and for intermediate, higher, advanced or top rate taxpayers in Scotland¹⁰. The Lifetime ISA bonus is equivalent to tax relief at the basic rate only, so higher and additional rate taxpayers lose out on higher relief by choosing a Lifetime ISA over a pension¹⁵. One worked comparison puts a gross £1,000 pension contribution as providing £400 of tax relief for a higher rate taxpayer, against a 25% Lifetime ISA bonus that is comparable to basic rate relief¹⁶.

Employer contributions make a workplace pension hard to beat

The single biggest difference between the two is employer money. In most cases your employer adds money into the pension scheme for you, and your employer must make contributions³. Legally, minimum contributions to a workplace pension are 8% of your qualifying earnings, with your employer contributing at least 3% and you making up the rest⁴.

That employer contribution has no equivalent in a Lifetime ISA. The regulator requires firms to warn that saving in a lifetime ISA instead of enrolling in, or contributing to, a qualifying scheme, occupational pension scheme or personal pension scheme may lose the benefit of employer contributions¹⁷. The same warning covers the effect on means-tested benefits.

The size of the effect depends on how much you and your employer pay in. One illustration shows a saver starting at 22 who pays the minimum 5%, while the employer pays 3%, ending up with £26,000 more at age 68 by raising their own contribution to 6%, £52,000 more at 7%, and £79,000 more at 8%¹⁸. Those figures are an illustration, not a promise, but they show how contributions compound over a working life.

There is also a tax difference in how contributions are treated. Employers do not pay National Insurance on pension contributions, but employees and self-employed people do¹⁹. That affects the true cost of paying in, and it is one reason salary sacrifice arrangements can be more efficient than paying from taxed income.

When you can take the money out

A Lifetime ISA used for retirement cannot be touched until you are 60⁴. From that point you can make as many withdrawals as you like without paying the government withdrawal charge²⁰. You can also take money out earlier to buy a first home, provided the property is worth no more than £450,000 and you are buying with a mortgage².

A pension is accessible earlier. You cannot take money from a pension until you are at least 55, rising to 57 in 2028, but you can do so at any point after that⁸. That is five years sooner than a Lifetime ISA, and the gap widens if the pension age rises again while the Lifetime ISA age stays at 60.

The two also differ in how flexible the withdrawals are. A pension gives you a range of options for taking money, including taking the whole pot, buying an annuity, or moving into drawdown²¹. A Lifetime ISA is simpler: once you reach 60, you take what you want, when you want it.

The Lifetime ISA withdrawal charge: losing more than the bonus

Take money out of a Lifetime ISA for anything other than a first home or retirement and a 25% charge applies to the amount you withdraw². The charge is designed to recover the government bonus, but it does more than that. Because it applies to the total amount, including the bonus, the effect is that you lose the government bonus plus 6.25% of your own contributions¹⁵.

The arithmetic is worth following. Assume no growth: initial savings of £800 earn a 25% government bonus of £200, giving a pot of £1,000. Withdrawing the entire pot means a government withdrawal charge of £250, leaving £750². You have paid in £800 and get back £750, so you are £50 worse off than if you had never used the account.

The charge also applies to partial withdrawals. If you need £120 in cash, you have to withdraw £160, pay a 25% charge of £40, and receive £120². The regulator's rules describe the charge as recovering any lifetime ISA government bonus and any investment growth on that bonus, plus an additional amount, so the client could receive back less than they paid in¹⁷.

The charge has changed before. During the coronavirus period the charge was temporarily reduced to 20%, meaning investors would only lose the government bonus earned on the amount they withdrew²³. That reduction has ended, and the standard rate is 25%².

How each one is taxed when you take it

A Lifetime ISA is tax-free on the way out. You pay no tax on the interest you earn, and withdrawals made for a first home or from age 60 are not taxed as income¹⁰. The bonus is added on top and is not taxed when you take it.

A pension is taxed differently. Income from pensions is taxed in the same way as your earnings and any other sources of income you receive, such as savings interest²⁴. So while you get relief going in, you pay income tax on much of the money coming out. How much depends on your total income in retirement, and the personal allowance applies as it does to other income.

There is a further difference on death. A Lifetime ISA has the same inheritance tax treatment as other ISAs, and the account forms part of your estate²⁵. A pension is usually outside your estate, and if you die before age 75 it can usually be inherited tax-free²¹. That makes pensions more efficient for passing money on, particularly for larger estates.

Using a Lifetime ISA and a pension together

The two products are not mutually exclusive, and the evidence suggests they can work alongside each other. A parliamentary committee concluded that cash Lifetime ISAs may not be the best way to save for retirement, but stocks and shares Lifetime ISAs can be a useful complementary retirement saving vehicle for some people, including the self-employed¹⁵.

That distinction between cash and investments matters. A cash Lifetime ISA holds money at low risk but with limited growth, while a stocks and shares Lifetime ISA invests for the long term²⁶. For retirement saving over decades, the investment version is the one the committee saw as complementary.

The Lifetime ISA is also designed to serve two purposes. It is intended for house purchase, retirement, or both, either in the alternative or in combination¹⁷. So a saver can use it to buy a first home, and if there is money left, or they carry on contributing, the pot can stay invested for retirement. Buying with someone else who also has a Lifetime ISA means you can both use your savings and government bonus, provided you both meet the first-time buyer conditions².

For the self-employed, who have no employer contribution to lose, the Lifetime ISA can fill a gap. Guidance on saving for retirement without a workplace pension includes the Lifetime ISA among the options¹³. The self-employed can also use a personal pension, which brings tax relief at their marginal rate¹³.

Criticism of the Lifetime ISA and possible changes

The Lifetime ISA has attracted sustained criticism. A Treasury Committee report in 2018 criticised it for its complexity, its perverse incentives, its lack of complementarity with pensions saving and its lack of popularity, and recommended abolition¹⁵. A later committee conclusion was that the Lifetime ISA may divert people from saving in more efficient pensions¹⁵.

The withdrawal charge has been a particular target. The committee found that the charge causes holders to lose the government bonuses they have received, plus 6.25% of their own contributions¹⁵. It also noted that retirement savings in Lifetime ISAs are included within the Universal Credit eligibility assessment, which is inconsistent with all other pension savings¹⁵. There are no plans to change the way savings held in a Lifetime ISA are treated in the assessment of Universal Credit¹⁵.

There has been speculation about the scheme's future. One report describes the Lifetime ISA as being scrapped, and refers to removing the component that helps people save for retirement²⁷. No change has been made to the rules as they stand, and the account remains available on the current terms.

Where to get help

Free, impartial guidance on pensions is available from Pension Wise, which covers taking a whole pot and the other options for cashing in a pension²¹. For workplace pension questions, guidance is available on how schemes work and what happens when your circumstances change¹¹. If you have a complaint about a Lifetime ISA or a pension that a firm has not resolved, the Financial Ombudsman Service can look at it²².