How to add an extra £5k to your annual pension savings limit
The new Lifetime ISA (LISA) was launched to help people buy a first home or save for retirement, but it can also be useful for those who have exhausted their pension annual allowance.
The LISA is subject to ISA rather than pension rules, meaning contributions will not count towards your annual allowance.
What is the annual allowance?
The annual allowance is the amount of money you can pay into your pension pot every year and get tax relief on.
It currently stands at £40,000 a year or 100% of your earnings, if lower, for most people. Anything above the threshold is subject to a tax charge.
For higher earners – those earning over £150,000 – the annual allowance is reduced or ‘tapered’, which essentially reduces the annual allowance by £1 for every £2 of income, bottoming out at £10,000.
There’s also another limit pension savers need to be aware of – the lifetime allowance. This is the amount you can save into a pension without triggering an excess tax charge at retirement and it currently stands at £1m. Anyone who exceeds this lifetime limit is hit with a 25% tax bill on the excess if the money’s withdrawn as income, or 55% if the money’s taken as a cash lump sum.
While other pension rules such as carry forward enable you to save more into your pension by using allowances going back three previous tax years (as long as you meet certain criteria), the LISA may be beneficial for high earners affected by the tapered annual allowance and those who’ve already exhausted limits in the previous tax years.
The Lifetime ISA
As LISAs are a type of ISA, contributing to the scheme for the purpose of retirement savings has no impact on current annual or lifetime pension allowances.
Under the LISA rules, people aged 18-39 can save up to £4,000 a year until the age of 50 and the government will add a 25% bonus, up to a maximum of £1,000 per year.
This means savers can save an additional £4,000 a year (£5,000 including the bonus) for their retirement without eating into their annual or lifetime pension allowance. See YourMoney.com’s All you need to know about the Lifetime ISA for further details.
Kate Smith, head of pensions at Aegon, says the LISA rules mean people can simultaneously pay into a LISA and a pension, which may be particularly useful if pension allowances have been exhausted, but the benefits are limited.
She says: “This option may be quite limited and won’t be open to all. It’s only possible to open a LISA between the ages of 18 and 39. People can only make contributions and receive the government 25% bonus until they are 50. So individuals will need to make sure they open a LISA before their 40th birthday to keep their options open if they believe they will use up their pension annual or lifetime allowances.
“The very highest earners with ‘adjusted income’ of £150,000 or more have a tapered annual allowance which reduces to £10,000 a year for those with adjusted income of more than £210,000. Saving in a LISA for retirement may be attractive for this group of people, but only if they fit the age eligibility criteria. However, the £4,000 contribution limit may restrict its appeal for this group.
“It makes sense for someone in their late 30s to take out a LISA for retirement if they are fairly certain they will use up their pension allowances at some point in the future; this will need a lot of future thinking.”
Pension or Lifetime ISA?
Smith says that using a pension to save for retirement is nearly always going to be better than using a LISA as you benefit from valuable employer contributions and get tax-relief at your highest marginal rate, plus the government continues to top up personal contributions until the age of 75.
David Newman, head of pensions at Close Brothers Asset Management, echoes this point.
“If the specific purpose of the money you are looking to invest is for longer-term retirement savings, and particularly if you are employed, where you can benefit from employer’s contribution, or a higher rate taxpayer, then a pension is likely to be the better option.
“If you have used a pension to mitigate your higher rate tax liability and are unable to benefit from any further employer contributions then a LISA is worthy of consideration, but currently there are far fewer choices of LISA providers compared to pensions.”