If you are saving for your pension, you will already be aware of the two most important acronyms in long-term tax-free saving: SIPPs and LISAs.
The Self Invested Personal Pension (SIPP) was introduced in 1990 as a way for people to save for their retirement without being taxed on the compound interest that they earned along the way.
Meanwhile, the Lifetime ISA (LISA) was launched just last year and serves two purposes. LISA savers can use their funds to buy their first home (up to the value of £450,000), or they can use it as a pension fund.
When it comes to pension savings, there is very little difference between the SIPP and the LISA, but certain investors will find some notable pros and cons.
SIPPs for Pension Saving – the Pros
SIPPs were designed for pension savings, and they offer a level of flexibility that LISAs can’t rival. A SIPP is a tax-free wrapper that allows savers to invest up to £40,000 per year without taxation.
Any returns made through a SIPP will be protected from capital gains tax and income tax, so savers can keep as much of their money as possible.
SIPPs also allow savers to manage their own pension fund, and to invest in a huge range of sectors. Stocks and shares, bonds, investment funds, gold bullion and even cash accounts are all eligible for SIPP inclusion, so each investor can choose the pension portfolio that works best for them.
This also means that SIPP holders can hold their SIPP investments across a range of different platforms and financial institutions, and these funds can be easily transferred if need be.
SIPPs for Pension Saving – the Cons
Unlike the LISA, SIPP savings are subject to taxation once withdrawals begin. However, this tax bill should be relatively small, as the average post-retirement income tends to be substantially less than the average salary.
This means that rather than being taxed at 40 or 45 per cent, a higher-earning pensioner may see their SIPP taxed at just 20 per cent. And if annual SIPP withdrawals amount to less than £11,850, there will be no tax payable at all.
It is also worth noting that the first 25 per cent of SIPP funds can be taken out as a lump sum without any taxation at the point at which the account holder reaches retirement.
Furthermore, SIPP holders cannot take any money out of their SIPP funds until their 55th birthday, and early withdrawals will be subject to some steep penalties. This may not suit some savers who wish to make smaller withdrawals before the age of 55.
LISAs for Pension Saving – the Pros
LISAs were created to encourage younger people to save for retirement (or buy a first home).
To promote the scheme, the government has pledged to add a 25 per cent tax free bonus on all annual LISA investments up to the value of £4,000 – this means that LISA pension savers can net up to £1,000 in free money every single year.
By all accounts, a guaranteed annual return of 25 per cent is incredibly hard to beat, and this is probably the biggest incentive for pension savers to use the LISA scheme.
On top of the 25 per cent bonus, LISA holders can also receive interest on their capital investment, although the amount of interest will depend on how the LISA is being invested.
There is only one Cash LISA fund currently available in the UK, offering 0.75 per cent per annum.
All other LISA accounts are treated in a similar way to Stocks and Shares ISAs, so the returns can vary considerably depending on the portfolio chosen.
LISAs for Pension Saving – the Cons
There is a time limit on your investing. LISAs can only be opened by taxpayers under the age of 39, and you can only invest until your 50th birthday. After that, you will have to leave the fund alone until you chose to withdraw it after you turn 55.
Furthermore, LISA account holders can put aside just £4,000 per year. This means that long-term pension savers cannot rely on their LISA alone.
If you opened a LISA on your 18th birthday and saved into it until you turned 50, you would not be able to save more than £128,000 over the course of your adult life – or £160,000 including the government bonus.
Given that the average retiree needs a pension fund of £300,000, this is unlikely to be enough to cover the costs of a long retirement.
Also published on Medium.Last updated: May 18th, 2018