LISA v Additional pension contributions

w00519773

I have a pension with my current employer and I make regular contributions (as does my employer), which benefits from salary sacrifice.
I have some disposable income free at the end of the month and I want to invest it in either my pension (additional contributions - I believe this is allowed though I am not sure) or a Lifetime ISA.  I have researched this, which tells me there is a 25% contribution from the government in a LISA and a 20% contribution (because it is free of tax) in the pension.  Therefore a LISA sounds more appealing.  However, the pension benefits from salary sacrifice.  On that basis I believe I should increase the contributions to my pension.  Have I understood this correctly? Does being a lower rate tax payer v higher rate tax payer have any relevance here?

TVAS

Maximum tax relief on LISA 4k
Maximum tax relief on maximum annual pension contribution 8k
Of course it does if you pay 40% tax and by making further pension conts to take you to basic rate you are paying less tax now and instead paying more into pension to be claimed at a later date.

hugheskevi

If you consider what you can do with £100 of gross pay, the possible outcomes are :

• Take as cash (after 12% NI and 20% income tax): £68 into bank account
  
• Salary sacrifice into pension: £100 into pension
  
• Take as cash (£68) and put money into LISA and get uplift: £85

The £100 in a pension will be taxable when drawn, after taking 25% tax free and paying 20% basic rate tax on the remainder you would have £85 (ignoring charges and investment growth, which will be neutral if investing at same charge rate in same assets in the LISA and pension).

So with the assumptions used above (basic rate tax payer, paying 12% rate of National Insurance, no contribution from employer in return for salary sacrificing additional amount, basic rate taxpayer when pension drawn and income tax rates do not change) there is little to choose between pension or LISA for additional funds. Change any of the assumptions and the result changes.

kuratowski

I think you have slightly misunderstood.  The two percentages have different bases, 20% is off the gross whereas 25% is added to the net.  Adding 25% to the net would be the same as refunding 20% tax paid.

However, when comparing pensions vs LISAs you also need to consider the tax situation at retirement.  Money paid into LISAs (from post-tax income) is tax free forever.  However, money paid into pensions will be taxed when the income is taken in retirement: 25% can be taken tax free, but the rest will be taxed at your marginal rate.  So the true comparison needs to factor this in.  Also, you have mentioned that your pension contributions are paid by salary sacrifice.  This means a saving of National Insurance at 12% on the money going in, so we have to factor this in as well.

Here is how the comparison works taking all of this into account:

Pension contributions with salary sacrifice:  Gross income £100 all goes into the pension.  At retirement, 25% is taken tax free.  The remaining 75% is taxed at 20%, so the total you receive is 100 - 0.75 * 0.20 * 100 = £85.

LISA: Gross income £100 is reduced by tax of £20 and NI of £12.  So £68 goes into the LISA.  But you receive a government bonus of 25%, this comes to 0.25 * £68 = £17.  And £68 + £17 = £85.

So financially they are both the same.  Although the taxation of pensions could well be changed by the government in the future, in which case all bets are off!

Also, the age you can access a LISA is 60 and the age you can access a pension is currently 55, although the government is consulting on raising the pension access age to 57.  Further, the MSE Lifetime ISAs guide mentions a few other differences, such as the different treatments of pensions vs LISAs in case of bankruptcy or claiming benefits.

Edit: Hugheskevi beat me to it!

Thrugelmir

kuratowski said:

Pension contributions with salary sacrifice:  Gross income £100 all goes into the pension.  At retirement, 25% is taken tax free.  The remaining 75% is taxed at 20%, so the total you receive is 100 - 0.75 * 0.20 * 100 = £85.

Only once the annual personal tax allowance is utilised. 

w00519773

hugheskevi said:

If you consider what you can do with £100 of gross pay, the possible outcomes are :

• Take as cash (after 12% NI and 20% income tax): £68 into bank account
  
• Salary sacrifice into pension: £100 into pension
  
• Take as cash (£68) and put money into LISA and get uplift: £85

The £100 in a pension will be taxable when drawn, after taking 25% tax free and paying 20% basic rate tax on the remainder you would have £85 (ignoring charges and investment growth, which will be neutral if investing at same charge rate in same assets in the LISA and pension).

So with the assumptions used above (basic rate tax payer, paying 12% rate of National Insurance, no contribution from employer in return for salary sacrificing additional amount, basic rate taxpayer when pension drawn and income tax rates do not change) there is little to choose between pension or LISA for additional funds. Change any of the assumptions and the result changes.

Thanks.  Lets say I opened a LISA today to invest money I have already paid tax and NI on i.e. £68 (topped up to £85 with the tax refund) and I also invested £100 in my pension.  Lets say that the value of my pension did not change between now and withdrawal.  At withdrawal:
1) The pension sum would be worth £85 i.e. 100-((20/100)*75)=£85
2) The LISA would still be worth £85
I guess the benefit of the pension is that you have £100 to invest instead of £85 meaning potentially more gains over the life of the investment.  On that basis it would be more advantageous to invest in the pension.
If I was a higher rate tax payer then I would still only get a 25% bonus on the LISA contribution, however I would receive 40% tax relief on additional contributions to the pension.
Have I understood this correctly?

Anonymous101

Couple of points for me.
Tax on pensions - As well as the 25% TFSL you have to also consider the personal allowance with regard to how much you’ll likely be drawing. Allowance is currently £12.5k so if you’re drawing £25k annually that’s effectively a 10% tax as the 20% rate is only applied to half of it.

My second point is regarding you comment 2, that you’d see better gains on the £100 than the £85. That’s true but then you’d see high taxes too. It doesn’t make a difference in the end as mathematically the sequence of calculations is not important.

£100 x 80% (20% tax) x 200% (growth) =
£100 x 200% (growth) x 80% (20% tax)

Finally Lisa’s do have a value for high earners. If you’re either restricted by the annual taper or endanger of exceeding the LTA then a LISA is a good bolt on the a pension.

kuratowski

w00519773 said:
I guess the benefit of the pension is that you have £100 to invest instead of £85 meaning potentially more gains over the life of the investment.  On that basis it would be more advantageous to invest in the pension.

Not really.  Both investment growth and taxation work by multiplication, and it doesn't matter in what order you perform multiplication, the result is the same either way.  That is, (1 - tax rate) * (1 + growth) = (1 + growth) * (1 - tax rate).

If I was a higher rate tax payer then I would still only get a 25% bonus on the LISA contribution, however I would receive 40% tax relief on additional contributions to the pension.

Correct, for higher rate tax payers, pension savings are better.  At least, until you start hitting the limits on tax relief.

Edit: Beaten to it for the second time, this time by Anonymous101

grumiofoundation

w00519773 said:

hugheskevi said:

If you consider what you can do with £100 of gross pay, the possible outcomes are :

• Take as cash (after 12% NI and 20% income tax): £68 into bank account
  
• Salary sacrifice into pension: £100 into pension
  
• Take as cash (£68) and put money into LISA and get uplift: £85

The £100 in a pension will be taxable when drawn, after taking 25% tax free and paying 20% basic rate tax on the remainder you would have £85 (ignoring charges and investment growth, which will be neutral if investing at same charge rate in same assets in the LISA and pension).

So with the assumptions used above (basic rate tax payer, paying 12% rate of National Insurance, no contribution from employer in return for salary sacrificing additional amount, basic rate taxpayer when pension drawn and income tax rates do not change) there is little to choose between pension or LISA for additional funds. Change any of the assumptions and the result changes.

Thanks.  Lets say I opened a LISA today to invest money I have already paid tax and NI on i.e. £68 (topped up to £85 with the tax refund) and I also invested £100 in my pension.  Lets say that the value of my pension did not change between now and withdrawal.  At withdrawal:
1) The pension sum would be worth £85 i.e. 100-((20/100)*75)=£85
2) The LISA would still be worth £85
I guess the benefit of the pension is that you have £100 to invest instead of £85 meaning potentially more gains over the life of the investment.  On that basis it would be more advantageous to invest in the pension.
If I was a higher rate tax payer then I would still only get a 25% bonus on the LISA contribution, however I would receive 40% tax relief on additional contributions to the pension.
Have I understood this correctly?

The fact you have more to invest in the pension (£100 be £85) makes no difference in the situation you have described (BRT payer now and in retirement). 

Imagine if both investments quadrupled 
LISA now worth £340 - no tax due 
pension now worth £400 - after 25% Tax free and 20% tax on the rest = £340.

For a higher rate tax payer paying basic rate in retirement pension beats LISA. (If you would be higher rate tax payer in retirement then pension is the slightly better/the same as LISA - depending if pension via salary sacrifice or not respectively).

There are obviously other things to consider deciding pension vs LISA and of course ^this^ is all assuming tax rates will be the same when you retire as they are today!

edit: beaten to it x2! Damn you train tunnels...

w00519773

grumiofoundation said:

w00519773 said:

hugheskevi said:

If you consider what you can do with £100 of gross pay, the possible outcomes are :

• Take as cash (after 12% NI and 20% income tax): £68 into bank account
  
• Salary sacrifice into pension: £100 into pension
  
• Take as cash (£68) and put money into LISA and get uplift: £85

The £100 in a pension will be taxable when drawn, after taking 25% tax free and paying 20% basic rate tax on the remainder you would have £85 (ignoring charges and investment growth, which will be neutral if investing at same charge rate in same assets in the LISA and pension).

So with the assumptions used above (basic rate tax payer, paying 12% rate of National Insurance, no contribution from employer in return for salary sacrificing additional amount, basic rate taxpayer when pension drawn and income tax rates do not change) there is little to choose between pension or LISA for additional funds. Change any of the assumptions and the result changes.

Thanks.  Lets say I opened a LISA today to invest money I have already paid tax and NI on i.e. £68 (topped up to £85 with the tax refund) and I also invested £100 in my pension.  Lets say that the value of my pension did not change between now and withdrawal.  At withdrawal:
1) The pension sum would be worth £85 i.e. 100-((20/100)*75)=£85
2) The LISA would still be worth £85
I guess the benefit of the pension is that you have £100 to invest instead of £85 meaning potentially more gains over the life of the investment.  On that basis it would be more advantageous to invest in the pension.
If I was a higher rate tax payer then I would still only get a 25% bonus on the LISA contribution, however I would receive 40% tax relief on additional contributions to the pension.
Have I understood this correctly?

The fact you have more to invest in the pension (£100 be £85) makes no difference in the situation you have described (BRT payer now and in retirement). 

Imagine if both investments quadrupled 
LISA now worth £340 - no tax due 
pension now worth £400 - after 25% Tax free and 20% tax on the rest = £340.

For a higher rate tax payer paying basic rate in retirement pension beats LISA. (If you would be higher rate tax payer in retirement then pension is the slightly better/the same as LISA - depending if pension via salary sacrifice or not respectively).

There are obviously other things to consider deciding pension vs LISA and of course ^this^ is all assuming tax rates will be the same when you retire as they are today!

edit: beaten to it x2! Damn you train tunnels...

Thanks.  I guess it is allowed to benefit from the max tax refund from the pension and the max tax refund from a LISA? I am not planning to do this as I cannot afford it.

grumiofoundation

w00519773 said:

grumiofoundation said:

w00519773 said:

hugheskevi said:

If you consider what you can do with £100 of gross pay, the possible outcomes are :

• Take as cash (after 12% NI and 20% income tax): £68 into bank account
  
• Salary sacrifice into pension: £100 into pension
  
• Take as cash (£68) and put money into LISA and get uplift: £85

The £100 in a pension will be taxable when drawn, after taking 25% tax free and paying 20% basic rate tax on the remainder you would have £85 (ignoring charges and investment growth, which will be neutral if investing at same charge rate in same assets in the LISA and pension).

So with the assumptions used above (basic rate tax payer, paying 12% rate of National Insurance, no contribution from employer in return for salary sacrificing additional amount, basic rate taxpayer when pension drawn and income tax rates do not change) there is little to choose between pension or LISA for additional funds. Change any of the assumptions and the result changes.

Thanks.  Lets say I opened a LISA today to invest money I have already paid tax and NI on i.e. £68 (topped up to £85 with the tax refund) and I also invested £100 in my pension.  Lets say that the value of my pension did not change between now and withdrawal.  At withdrawal:
1) The pension sum would be worth £85 i.e. 100-((20/100)*75)=£85
2) The LISA would still be worth £85
I guess the benefit of the pension is that you have £100 to invest instead of £85 meaning potentially more gains over the life of the investment.  On that basis it would be more advantageous to invest in the pension.
If I was a higher rate tax payer then I would still only get a 25% bonus on the LISA contribution, however I would receive 40% tax relief on additional contributions to the pension.
Have I understood this correctly?

The fact you have more to invest in the pension (£100 be £85) makes no difference in the situation you have described (BRT payer now and in retirement). 

Imagine if both investments quadrupled 
LISA now worth £340 - no tax due 
pension now worth £400 - after 25% Tax free and 20% tax on the rest = £340.

For a higher rate tax payer paying basic rate in retirement pension beats LISA. (If you would be higher rate tax payer in retirement then pension is the slightly better/the same as LISA - depending if pension via salary sacrifice or not respectively).

There are obviously other things to consider deciding pension vs LISA and of course ^this^ is all assuming tax rates will be the same when you retire as they are today!

edit: beaten to it x2! Damn you train tunnels...

Thanks.  I guess it is allowed to benefit from the max tax refund from the pension and the max tax refund from a LISA? I am not planning to do this as I cannot afford it.

The LISA bonus is not a tax refund.