The use of LISAs in retirement planning

Lifetime ISAs were introduced by the UK government in 2017 to help younger people save for two key financial goals: buying their first home and retirement. With the promise of a 25% government bonus on contributions up to £4,000 a year, it’s easy to see why they’ve gained popularity. However, while the offer of free money might seem like a great deal, LISAs have several limitations when it comes to long-term retirement planning.

While LISAs may serve a purpose for homebuyers, relying on them as a primary retirement tool is risky. We’ll explore these limitations and why pensions, with their larger allowances, tax relief, and employer contributions, often offer a better route to long-term financial security.

What is a Lifetime ISA?

A LISA is a type of Individual Savings Account (or ISA) designed specifically to help individuals save for their first home or for retirement. It’s available to UK residents aged between 18 and 39, and allow contributions until age 50. Here’s how it works:

  • Contribution Limits: You can save up to £4,000 each tax year, and the government will add a 25% bonus to contributions. This means you can receive a bonus of up to £1,000 each year.

  • Tax-Free Growth: Like other ISAs, any interest, dividends, or capital gains on investments within the LISA are tax-free.

  • Purpose: Funds in a LISA can be used for one of two things: to purchase a first home or to access after the age of 60 as part of retirement planning.

  • Withdrawals: If you withdraw the funds before the age of 60 and not for a first home purchase, you’ll face a 25% penalty on the amount withdrawn. This penalty effectively removes the bonus and may even reduce the value of your initial contribution.

Lifetime ISAs vs. Help-to-buy ISAs

Before LISAs were introduced, the Help-to-Buy ISA was a popular scheme for first-time buyers. It’s important to compare these two products to understand why the LISA was seen as an upgrade—and where it now falls short.

  • Help-to-Buy ISA Overview: The Help-to-Buy ISA was available from December 2015 until November 2019. Like the LISA, it offered a 25% government bonus, but the maximum bonus was capped at £3,000. You could contribute up to £200 per month, and the government would match 25% of what you had saved, but was only paid when purchasing a first home.

    So how did they differ?

    • Contribution Limits: The LISA allows for a larger annual contribution of £4,000 compared to the Help-to-Buy ISA’s monthly cap of £200, a difference of £1,600 annually.

    • Bonus Structure: The Help-to-Buy ISA bonus was only paid out when purchasing a home, while the LISA bonus is added each month, allowing the bonus to compound with any investment growth.

    • Home Purchase Value: Help-to-Buy ISAs had a limit where the value of the property being purchased could not exceed £250,000 (or £450,000 in London). Lifetime ISAs have no such cap on property value.

Despite these advantages, the Lifetime ISA’s appeal diminishes significantly when we focus on retirement planning. Unlike pensions, which come with higher contribution limits, tax relief, and employer contributions, the LISA’s £4,000 limit and restrictions on withdrawal make it far less flexible for long-term savings.

The pitfalls of using a Lifetime ISA for retirement Planning 

While the Lifetime ISA offers tax-free growth and a government bonus, it falls short when compared to other retirement savings vehicles, particularly pensions. Here’s why:

  • Low Contribution Limits: The £4,000 annual contribution limit, while decent for first-time buyers, is inadequate for long-term retirement savings. For comparison, you can contribute up to £60,000 into a pension annually and still benefit from tax relief. If you’re serious about building a substantial retirement pot, the LISA’s cap won’t provide enough room to grow your wealth effectively.

  • Government Bonus vs. Pension Tax Relief: One of the most attractive features of a pension is the immediate tax relief on contributions. If you’re a basic rate taxpayer, the government adds 20% to your pension contributions, and if you’re a higher- or additional-rate taxpayer, you can claim back 40% to 45%. This far exceeds the 25% bonus offered by the LISA. We’ve explored the benefits of pension contributions here.

  • No Employer Contributions: With workplace pensions, many employers can match or even exceed pension contributions, which essentially gives “free money” to grow retirement savings. LISAs don’t offer this benefit, so you miss out on this crucial boost.

  • Withdrawal Restrictions: Unlike pensions, where you can access your funds starting at age 55 (moving to 57 in 2028), funds within a Lifetime ISA funds can’t be accessed until 60 without facing a 25% penalty. This penalty not only claws back the government bonus but could leave you with less than you originally invested.

  • The Impact of the Penalty: The 25% withdrawal penalty is designed to discourage investors from using LISA funds for anything other than a first home or retirement. However, this penalty can equates to a 31.25% loss on an initial contribution, which can be significant if you need access to your money before you turn 60. For example, if you contribute £100 to a LISA, you’ll receive a bonus of 25% from the government, or £25. If you withdraw these funds before retirement and incur the 25% penalty, this’ll be charges against the total fund value, that is, 25% of £125. You’ll therefore pay a penalty of £31.25, exceeding the initial bonus paid. 

Case Study - Why a Lifetime ISA is a poor choice for retirement

Emma is 30 years old and has just started thinking about her retirement. She earns £35,000 a year and is considering whether to invest in a Lifetime ISA or make use of her workplace pension.

  • Option 1: Lifetime ISA
    In the first scenario, Sarah opens a Lifetime ISA and contributes the maximum £4,000 per year. Over the next 30 years, she invests a total of £120,000 and receives £30,000 in government bonuses. Assuming an average return of 5% per year, her LISA pot grows to approximately £280,000 by the time she’s 60.

  • Option 2: Workplace Pension
    Alternatively, Emma could invest in her workplace pension. She contributes 5% of her salary, and her employer matches this with another 5%. On top of this, she receives 20% tax relief, bringing her total annual pension contributions to £4,375 per year. Over the next 30 years, she contributes £131,250 (including tax relief and employer contributions). Assuming the same 5% annual return, her pension pot grows to around £400,000 by the time she’s 60.

  • Comparing the Outcomes:
    Even though Emma receives a 25% government bonus with her LISA, the overall retirement pot from her pension is significantly larger, thanks to employer contributions, tax relief, and higher annual contribution limits. In this scenario, Emma’s pension grows to £400,000 compared to £280,000 in her LISA—a difference of £120,000. Sarah is also personally paying less for her retirement with her workplace pension, with £52,500 being taken from her salary over 30 years, compared to a £120,000 personal contribution for maximizing her LISA over the same period.

The key takeaway here is that, while Lifetime ISAs provide a helpful bonus, they simply can’t compete with the advantages offered by workplace pensions, especially when employer contributions and tax relief are factored in.

Alternatives to the Lifetime ISA for retirement planning

It’s safe to say that if you’re planning for retirement, the Lifetime ISA is not the most efficient vehicle. Here are some alternatives that provide better flexibility and growth potential:

  • Workplace Pension:
    As mentioned earlier, workplace pensions provide tax relief, employer contributions, and higher contribution limits. These factors combined make pensions far superior to LISAs for long-term retirement planning.

  • Personal Pension (SIPP):
    For those who want more control over their investments, a Self-Invested Personal Pension (or SIPP), or personal pensions generally offer flexibility in terms of investment options. You can contribute up to £60,000 per year (or 100% of your earnings, whichever is lower) and still benefit from tax relief. Like workplace pensions, SIPPs and personal pensions offer far greater potential for growing retirement savings compared to a LISA.

  • Stocks and Shares ISA:
    While a Stocks and Shares ISA doesn’t come with the same tax relief or bonuses as a pension or LISA, it provides flexibility. You can invest up to £20,000 per year and access your funds at any time without facing penalties. This makes it a good complement to your pension, offering liquidity and tax-free growth.

Final Thoughts

While the Lifetime ISA can be a useful tool for first-time homebuyers, it falls short when used for retirement planning. The low contribution limits, lack of employer contributions, and withdrawal penalties make it a less attractive option compared to pensions, which offer greater tax benefits and flexibility.

For most people, contributing to a workplace pension or a SIPP will be a far better way to secure a pension pot, particularly when employer contributions and tax relief are taken into account. For most people, contributing to a workplace pension or a SIPP will be a much better way to secure a comfortable retirement. While LISAs may have their place in a wider financial plan, they shouldn’t be relied upon as the primary vehicle for retirement savings.

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The content on this page is accurate as of the 2024-25 tax year.