When should one use the new lifetime ISA in place of investing in pension?

Question

Assuming that I am not interested in purchasing a flat using lifetime ISA, is it ever advantageous for me to put money into it in place of a pension?

Since lifetime ISA gives 25% tax relief on investment, this is the same as it being tax free for basic rate taxpayers, and it is also tax free when one turns 60. It seems to me that for basic rate taxpayers it is more tax efficient to be in lifetime ISA than in a pension scheme. Am I missing something? Does this logic continue to hold for higher and additional rate taxpayers?

Since this question is complex and depends on a lot of variables, not least being rate of return on investments and future tax regime (when one draws income), let's make some simplifying assumptions:

• Real rate of return on investment is zero (ie pot grows exactly at the rate of inflation)
• Tax bands change also exactly at the rate of inflation (so no real changes in government tax policy)
• You can compute everything in today's GBP (then you don't need to worry about what the rate of inflation will be)

I am probably being a bit conservative on investment growth and optimistic on tax policy, but maybe on average not too wrong. The remaining variables then are:

• Current marginal tax bracket
• Current size of investment pot
• Expected total employer's contributions to the pot over the rest of my life (expressed in today's GBP)
• Other expected income outside of the pension (for instance rent on owned properties, etc)
• Assume my contribution is marginal (£1 say) so that you don't need to worry about any changes in the tax bracket

The last two variables allow you to compute the tax bracket I will be in when I retire and start drawing income. Assume that income will be drawn at 5% of the pot size per year. Ideally the answer should be precise and expressed in terms of the above variables. Extra kudos if you relax any of the assumptions, but it's not necessary for me to accept the answer and give a +1.

If you want to make different assumptions I will accept the answer as well so long as they're reasonable.

Answer 1

To answer the opposite question - cases where current pension schemes might be better:

• As you allude, if your tax rate is higher than 20%, say if you are taxed at 40% on a significant part of your income, say the amount you want to save or more, then the pension scheme may be better.

Otherwise it looks like it will be down to whether the pension (taking into account management charges) performs better than your particular Lifetime ISA (LISA).

• However, if you are lucky enough that your employer contributes to your pension or tops up extra contributions you make (contribution matching), then you may effectively "get more than 25%" as a basic rate tax payer.

And of course, should you reach your yearly limit for tax relief for pensions, then why not use the LISA!

• Finally once you pass 50 the government will no longer pay the bonus top-up for LISA contributions; at that point switching to paying into a current style pension scheme is likely better if they still exist. And when you can take the LISA money out at age 60, if still working, I guess you could put as much as you can each year into another pension if the returns are better.

• EDIT: It arguably also depends on your income during your pension. If you are a higher rate tax payer when pensioned, then the LISA may work out better, likewise if you are a basic rate tax payer before and after pension age, as you wouldn't pay tax on LISA income when withdrawing it. A few more breakdowns here. But again, beware that employer contributions in a workplace pension are not included in these, so they are probably most useful for self-employed people.

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Note a 25% bonus is required to better 20% tax relief on pensions as if you pay 20% tax on £100, then you are left with £80, if you then get a 25% bonus on that you are back to £100.