Pension vs LISA

john987

Hi


I have been considering whether it is worth saving into a LISA as well as my workplace pension. Bit of background:


34, higher rate taxpayer. Employer matches to 5% which I currently exceed.


Most of the comparisons I have seen seem to suggest an employer pension is a no brainer for a higher rate tax payer due to the combination of tax relief and employer contributions. However assuming you have maxed out your employer contribution I am wondering if a LISA makes more sense for additional contributions.


The reason being is although you only get 25% tax relief on contributions compared to 40% via employer contributions the LISA is tax free on withdrawal. On the other hand the pension will be taxed on withdrawal. Assume in this case I can withdraw 25% tax free and I am a basic rate tax payer when I retire. Say for example you invested £100 in both a LISA and a pension and they were worth £1,000 on retirement (with investment growth). This would cost £58 into a pension and £80 into a LISA. Assume this is after inflation (therefore the £1,000 is pure investment growth).


With the LISA you could withdraw the £1,000 tax free but with the pension even after the 25% tax free you would have to pay £150 tax. Therefore this would wipe out the initial saving you made when you put the money in. The reason being is you are being taxed on the growth of the fund in the pension where as the LISA the growth is tax free.


On this basis it would seem like the LISA is the better option. I appreciate the gap might be smaller than this in reality as to keep it simple I have ignore the tax free allowance (a good chunk of this will be taken up by the state pension).


Am I missing something?

Brynsam

If you can afford both, have both - but keep in mind that pension tax relief for higher rate taxpayers is constantly in government sights, so taking advantage of it while it is still with us is worth considering.

crv1963

As suggested by Brynsam I'd try to do both, more in a pension for tax relief but a LISA can't be opened after 40 and it may morph into something else. Creates another "pot of money" locked away for the future when you may need options.


Questions to ask yourself- do I want to work until I'm 68? Can I afford to put something into another pot? Is there a way I can gain/ take advantage of any free money (employer/ HMRC). What are my plans over the next year/ 5 year/ 20 year and how do I meet them?


Everyone has their take on planning. Our approach is spread across several areas, pay down debt, pay down mortgage, pay into pension, sure it's slower getting there but rather than concentrate on one thing at a time we're hoping it all comes together at the same time.

Alexland

I pay enough into the pension to get my income down to basic rate (and avoid paying back child benefit) and then contribute £4k into a S&S LISA. As my employer operates salary sacrifice to save NI the LISA is no more efficient than basic rate pension contributions however the main advantage for me is that a LISA doesn't count towards the pension annual allowance or LTA.

Alex.

dunstonh

34, higher rate taxpayer. Employer matches to 5% which I currently exceed.

Straight away we see the thing that makes pension better. Higher rate taxpayer. That means you get 40% relief on the pension contributions in your higher rate band. LISA does not. It gets the equivalent of basic rate.

However assuming you have maxed out your employer contribution I am wondering if a LISA makes more sense for additional contributions.

The employer contribution is the free money. You dont get tax relief on the employer contribution. You only get tax relief on your contribution. You can pay upto £40,000 a year into a pension (including employer contribution). So, you are probably some way off the limit.

The reason being is although you only get 25% tax relief on contributions compared to 40% via employer contributions the LISA is tax free on withdrawal.

You are not comparing correctly.

LISA equates to 20% when comparing to the tax relief on a pension. Not 25%. This is because they work differently. Pension contributions are gross of tax relief. So, £100 in would see a net contribution of £80 with a further £20 reclaimed via your tax code. So, a net cost of £60 to get £100. LISA adds a bonus on top of the contribution. So, £60 becomes £75.

So, on a like for like basis, a net £60 contribution sees the pension get £100 and LISA get £75. You are worse off by £25pm by going with LISA.

Say for example you invested £100 in both a LISA and a pension and they were worth £1,000 on retirement (with investment growth).

That outcome is not possible. The pension would always have a higher figure than the LISA because of the higher tax relief when you use the same net contribution amount (i.e. the same net monthly cost).

With the LISA you could withdraw the £1,000 tax free but with the pension even after the 25% tax free you would have to pay £150 tax. Therefore this would wipe out the initial saving you made when you put the money in. The reason being is you are being taxed on the growth of the fund in the pension where as the LISA the growth is tax free.

Pension value would be higher than the LISA value. So, whilst the LISA is tax free on withdrawls, it has a lower value. The pension is tax free on 25% and subject to 20% on the rest (assuming you will be basic rate in retirement, like most).

Pensions have tax free growth. In fact they are more tax free than LISAs.

Am I missing something?

Yes. As above, you are not comparing on the same NET cost starting point. So, putting both methods on the same cost to you:

£100pm of your money into LISA is £125 total contribution.
£100pm of your money into a pension is £167 total contribution.

If you ignore growth and assume basic rate tax in retirement, that £167 taken out would suffer £25 tax. So, £25 off £167 is £142. The LISA would have no tax so would be £125. £142 is higher than £125. Pension at higher rate relief beats LISA.

MK62

You do need to check though that you will be getting 40% tax relief on the whole pension contribution (or a large part of it)......depending on your salary and contribution amounts, you may not....


Personally I'd be doing what Alexland is doing.......(though LISAs were never an option for me due to the age discrimination.... )

kidmugsy

Suppose the pension contribution is not by salary sacrifice. At a cost of £60 you get £100 in the pension. Or at the cost of £60 you get £75 in the LISA. Both grow merrily at the same rates, and you consider withdrawing at 60 when you expect to be a basic rate taxpayer, and to have your personal allowance fully used by other pension payouts.

The LISA gives you income proportional to £75. If basic rate remains at 20% then the pension gives you payouts proportional to £85. The pension wins.

On the other hand if the basic rate has risen to 32% (about where it was in the early 1970s), the pension payout is proportional to £76, so it's Even Steven. If, in addition to 32% tax, the pension is afflicted by a cap on TFLS, then the pension payout might be proportional to only £68. The LISA wins.

Personally I'd be swayed by the argument for filling the pension while the 40% relief survives, while reserving yourself a berth on the RMS LISA by opening one now, if only for £1. Act now before that ship sails.

TheShape

john987 wrote: »

34, higher rate taxpayer. Employer matches to 5% which I currently exceed.

dunstonh wrote: »

Straight away we see the thing that makes pension better. Higher rate taxpayer. That means you get 40% relief on the pension contributions in your higher rate band. LISA does not. It gets the equivalent of basic rate.

As this is a question about whether additional contributions go to a pension or a LISA doesn't the answer as to which is better depend on the OP's salary? If the 5% pension contribution uses all the OP's income in the higher rate band do any additional contributions receive higher rate or basic rate relief?

Alexland

TheShape wrote: »

If the 5% pension contribution uses all the OP's income in the higher rate band do any additional contributions receive higher rate or basic rate relief?

If they are sufficiently stuffing their pension they would be a basic rate taxpayer and they declared themselves higher rate. I consider myself basic rate as that is the rate I choose to pay tax.

Alex

TheShape

Alexland wrote: »

If they are sufficiently stuffing their pension they would be a basic rate taxpayer and they declared themselves higher rate. I consider myself basic rate as that is the rate I choose to pay tax.

Alex

Sorry Alex

Just so I'm sure of the answer. If someone is earning £46351 so paying 40% tax on £1 of earnings, do they only receive higher rate tax relief on £1 of pension contributions with any additional contributions only receiving 20% tax relief?

Thanks

kidmugsy

TheShape wrote: »

If someone is earning £46351 so paying 40% tax on £1 of earnings, do they only receive higher rate tax relief on £1 of pension contributions with any additional contributions only receiving 20% tax relief?

Correct. You get tax relief on a £ at the rate you paid tax on that £ (except at the low end where you can get tax relief on money that never did pay any tax).