Saving for Self-Employed Retirement: LISA or Pension

Self-employment is as rewarding as it is burdened by a host of new responsibilities. Choosing between a lifetime ISA or pension is one of the more important self-employed decisions you’ll have to make sooner rather than later.

Both a LISA (lifetime ISA) and SIPP (self invested personal pension) can be valid choices when saving money for retirement, but it’s important to understand the differences between each before making a decision to open one, the other, or a combination of both.

By the end of this article, the team at UWM hope you’ll be better equipped to start saving for the future.

We’re going to discuss:

• What a LISA is
• What a SIPP (pension) is
• The differences between a LISA and SIPP
• Tax breaks and contributions
• Withdrawal
• Which pension plan is better for the self-employed

What is a LISA?

Individual savings accounts, or ISAs, are intended to help people save for medium- to long-term goals like paying university tuition fees, buying a car, or organising a wedding. A lifetime ISA (LISA) differs in that you can only use it to save for buying your first home, or for retirement. Withdrawals outside these two remits incur a hefty 25% penalty. Contributions into LISAs are made from after-tax income, and are given a favourable tax status. A LISA can be held in cash or in stocks and shares. Whilst the latter can be riskier, it also offers the potentially higher return.

What is a SIPP (pension)?

For those of us registered for Self Assessment with the HMRC “ either as sole traders or with our own Limited Company “ we are ineligible for a workplace pension. Instead, if we want a pension plan, we have to open a SIPP (self invested personal pension) instead. Nevertheless, a SIPP isn’t all that different from a workplace pension: all the money invested in a SIPP comes from your pre-tax self-employed income; the UK government allows tax rebates on contributions to a SIPP; and, in return, access to SIPP funds is blocked until you reach 55-years-old (increasing to 58-years-old by 2028). In contrast to workplace pensions, however, self-employed SIPP owners can choose to exert partial or even full control over their pension plan investment portfolio.

LISA vs Pension

Choosing between a lifetime ISA or pension when self-employed doesn’t have to be a stressful decision. With the right information, we can help you to make a decision based on factors which are relevant to your unique self-employed situation. First, let’s take a look at a LISA vs pension across your primary concerns for money, security, restrictions and incentives.

Eligibility

There’s not much difference in eligibility for a LISA vs pension as a self-employed person. You can open a private pension account at any point in life, provided you’re still earning, whereas you must be older than 18 and younger than 40 to open a LISA, but can still contribute to the LISA until you turn 50. These differences in eligibility between a lifetime ISA and pension should only affect the decisions of older self-employed people who are close to, or have surpassed the LISA age cap.

Flexibility

Neither a pension nor a lifetime ISA is intended to be particularly flexible, and for good reason: they are designed to help you save for long-term goals and retirement, and as such should not be dipped into whimsically as you might with a regular savings account.

Having said that, there is a slightly greater degree of flexibility with a LISA, in that you can withdraw your savings from it to buy your first house as well as when you reach retirement age. (Technically, you can withdraw from a LISA at any point, though unless for the reasons stated above you will incur a hefty 25% penalty on the amount withdrawn.)

On the contrary, pension pots are completely sealed to you until later in life.

Both a SIPP and a LISA allow you to make flexible contributions to your pot, depending on the nature of your income from month to month, and year to year.

Annual allowance

One of the biggest differences between a pension vs lifetime ISA is how much you can contribute in any given year. With a personally invested pension plan, you can technically invest your entire income, up to a maximum of £40,000 per year. Conversely, LISAs cap contributions at just £4,000 per year.

Tax breaks and contributions

The more complex side of the debate between lifetime ISAs or pensions for self-employed people is to do with tax.

With a SIPP, the government provides incremental tax reliefs determined by your taxpayer status. The higher your annual income, in effect, the greater the tax relief on contributions to your personal pension plan.

Basic-rate taxpayers get 20% tax relief on contributions as a ˜top-up’ from the government. Higher-rate tax payers can then claim an additional 20% relief on their self-assessment tax return, whilst additional-rate taxpayers can claim 25%, thus reducing their tax liability and effectively lowering the initial cost of their SIPP contributions.

Thus, to save £1,000 through a SIPP, you’d only have to contribute the following:

• Basic-rate taxpayer: £800
• Higher-rate taxpayer: £600
• Additional-rate taxpayer: £550

However, there is no tax relief on contributions made to a LISA. Instead, there is a constant 25% tax ˜bonus’ paid by the government on all contributions to a LISA up to the £4,000 annual cap. Thus, regardless of your tax band, contributions to a LISA would look like this:

• £100 contribution would become £125
• £1,000 contribution would become £1,250
• £4,000 contribution (max. in a year) would become £5,000

Note also that if you elect to open a Stocks and Shares Lifetime ISA, your contributions will fluctuate in value depending on the stock market. A more risk-averse alternative would be to open a Cash LISA.

It’s important to remember that the tax breaks and bonuses mentioned in this section may still be affected by taxes applied on the other end: i.e. to the money you withdraw.

Withdrawal

Age and use-case restrictions on withdrawal from pensions vs lifetime ISAs may factor into your investment decision, but it’s likely that the tax implications will prove more important.

All the money saved in a lifetime ISA or LISA is completely tax-free to withdraw. Thus, whilst you must make contributions from your post-tax income, this will be the last tax you pay on any money held in a LISA.

On the contrary, only the first 25% of your pension pot is tax-free to withdraw. After you’ve withdrawn this 25%, you will be taxed on all withdrawals from your SIPP at standard tax rates, depending on the amount you withdraw. In other words, 75% of withdrawals from a pension plan will be treated as income and taxed accordingly.

Which pension plan is better for self-employed people: SIPP or LISA?

In the UK, we’re all eligible to receive a state pension when we reach state pension age. This, however, is rarely sufficient to cover our needs in later life, and only becomes available up to a decade after other retirement-saving options.

As self-employed, it’s important to make provisions for our future, in the absence of a ˜normal’ workplace pension and employer contributions. Two options are available to us: a private pension, or SIPP, and a lifetime ISA, or LISA.

There are a number of pros and cons to a LISA vs pension, but ultimately the best choice depends on your personal circumstances. Of course, it’s important to remember that you don’t have to choose between a pension vs lifetime ISA. You can have both if it makes financial sense to you.

For assistance navigating the often-complex world of self-employed retirement planning, remember that you can always reach out to a trusted personal tax advisor for help.