Planning for retirement is never easy. There are a huge number of unknowns ahead, and it’s difficult to know how much to save, where to invest it, and how much will be required in retirement.
One of the problems with a pension is that it’s inflexible. If an individual saves into a pension, then they are unable to access any of the money until they are at least 55. For a younger person looking to build a nest egg for retirement at the same time as buying a property and coping with a variety of other costs throughout life, this can make them relatively unappealing.
As a result, a Lifetime ISA could be a worthwhile option. It seems to offer a mix of flexibility and high-return potential.
Return potential
A Lifetime ISA can be opened by any individual between the ages of 18 and 40. A maximum of £4,000 can be invested into the product per tax year, with any amounts paid in coming from after-tax income. This is different than a pension, where contributions are from before-tax income. As a result, it may seem as though a Lifetime ISA lacks the tax avoidance appeal of a pension.
However, for every £1 that is invested in a Lifetime ISA, the government will contribute a £0.25 bonus. This means that if an individual invests £4,000 through the product, the government will top-up the amount so that it reaches £5,000 per year. This helps to offset the potential tax advantage which a pension offers.
Furthermore, there is no capital gains payable on profits generated within a Lifetime ISA. While this may not seem to be of great importance at the start of an individual’s retirement-planning journey, in later years it could become increasingly worthwhile as a nest egg grows in size.
Flexibility
A Lifetime ISA also provides much greater flexibility than a pension. All contributions can be withdrawn at any time, but will be subject to a 25% charge. Any amounts withdrawn after the age of 60, though, are not subject to a penalty. And since income tax has already been paid on contributions, there will be no related tax to pay on withdrawals. This is markedly different to a pension, where 75% of withdrawals are subject to income tax.
A Lifetime ISA can also be used to fund the purchase of a first home. No penalty is levied if withdrawals are used for this purpose. This provides a younger person with the flexibility to plan for retirement, but to also benefit from the government bonus should they decide to use the money for a property purchase. In contrast, contributions to a pension cannot be withdrawn until an individual is at least 55 years old.
Outlook
While the Lifetime ISA has not proved especially popular since its launch, it seems to offer a sound mix of return potential, tax benefits, and flexibility. Therefore, for investors aged under 40, it could be a worthwhile method of building a retirement savings pot.