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Should you save into a Lifetime ISA, a pension or both?

We compare the Lifetime ISA and pensions, and how they shape up for retirement.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

All information is correct as at 30 June 2021 unless otherwise stated.

Both a Lifetime ISA (LISA) and a pension offer a tax-efficient way to save and invest for retirement. It’s important to know the ins and outs of each, to make sure you make the right choice for your situation. The option that offers the better benefits will depend on your circumstances and the product and tax rules that apply at the time, which can change.

First, you need to get to grips with the basics. Here’s a side-by-side comparison of how each account works.

How a LISA works

  • An investment account where your money has the chance to grow free of UK income tax and capital gains tax.
  • Open an account between age 18-39 and make contributions until age 50.
  • Pay in up to £4,000 each tax year and get a 25% bonus of up to £1,000 each year.
  • You’re free to take money out whenever you like. But if you make a withdrawal before age 60, which isn’t for a house purchase, an early exit penalty of 25% will usually apply. So you could get back less than you put in.

How a pension works

  • An investment account where your money has the chance to grow free of UK income and capital gains tax.
  • Open an account from age 18 with no upper age limit. A parent or guardian can also open a pension account for a child. You can make tax-relievable personal contributions until age 75.
  • Get up to 45% in tax relief on personal pension contributions. Pay in up to £40,000 every tax year (certain limits apply and different tax bands and rates apply for Scottish taxpayers).
  • Take money out from age 55 (rising to 57 in 2028). Up to 25% is normally tax free, the rest is taxed as income.

We hope you find these comparisons helpful, but this isn’t personal advice. If you’re unsure what’s right for you, ask for financial advice. Tax rules can change and any benefits depend on individual circumstances.

So which account comes up trumps for retirement saving?

A workplace pension normally takes the top spot. As a general rule, if your employer offers a workplace pension, that should be your first port of call for retirement savings.

Your employer is legally required to contribute an amount equal to at least 3% of your salary within a set band (providing you’re eligible). Lots of employers will match anything you pay into your pension up to a certain limit.

You also get tax relief on your pension contributions. If you want to put away more for your retirement, check if your employer will pay in more. The most any employer will contribute varies, so it’s worth getting in touch with them to confirm how much they’ll put in.

Another time a pension normally comes first is if your employer offers salary sacrifice and would agree to pay any National Insurance contribution rebate into your workplace pension.

If your employer is already contributing the maximum, or they won’t pay in more, then the most tax-efficient account (a LISA or a pension) to pay extra retirement savings into will depend on your personal circumstances – things like your salary and your tax situation.

Remember savings outside a pension (like a Lifetime ISA) could affect your entitlement to means-tested state benefits.

Earn up to £50,270? Here's why you should consider a LISA

For a basic-rate taxpayer, once you’ve maximised the yearly contributions from your employer, it could be more tax-efficient to pay the next £4,000 of your retirement savings into a LISA. That’s assuming your employer doesn’t offer salary sacrifice.

You get a 25% bonus from the government on money you pay into a LISA up to the £4,000 annual limit – that’s £1,000 in free money each tax year. When you come to withdraw after age 60, it will be completely tax-free . When you take money from a pension, usually only up to 25% is tax free. The rest (usually 75%) is taxable income.

Let's say you pay £4,000 into a LISA for ten years. You'd have a pot worth £50,000 which you could withdraw entirely tax free from age 60. If you pay the same amount into a pension, you’d also end up with a pot worth £50,000. That’s because basic-rate tax is currently 20%, and you’d get basic-rate tax relief on contributions, subject to limits.

But when you came to take the money out of the pension, you’d normally only get up to 25% (£12,500 in this case) tax free. The rest will be taxed as income.

This is just an example. It doesn't account for any investment growth, loss, or charges. Remember, unlike the security offered by cash, investments can fall as well as rise in value, so you could get back less than you invest. The value of cash can be eroded by the impact of inflation over time.

How much LISA bonus could you get?

Simply add how much you’d like to pay in each year and our calculator will show you the impact the government bonus has on your LISA. Visit our LISA calculator to find out.

Earn more than £50,270? Here’s why you should consider a pension (or both)

If you’re a higher-rate taxpayer, you’ll usually be better off paying extra retirement savings into a pension. This is because the extra tax relief you can get on pension contributions will offset the tax you pay on withdrawals later. That's assuming you’ll be a basic-rate taxpayer in retirement.

The 25% LISA bonus is effectively the same as a basic-rate taxpayer's pension tax relief. But as a higher earner, you can claim back more in tax relief through your tax return – making pension contributions more tax-efficient than LISA contributions.

Let's say you pay tax at 40%, you’d normally be entitled to tax relief of up to 40% on your personal pension contributions. If you paid £4,000 into a pension, you’d get up to £2,000 in tax relief. But if you paid the same amount into a LISA, you'd only get £1,000 in government bonus.

When to consider a LISA and pension

If you’re a higher earner you might be better off with a mix-and-match approach. You could pay into your pension to get all the higher rates of relief you can. Then once you’ve maxed out your pension allowances, you could consider putting the next £4,000 into a LISA and benefit from the LISA bonus.

For more on pension allowances visit our contributions page.

How much tax relief could you get?

Our calculator will show you how much tax relief you could get on your pension contributions. Simply confirm how much you earn and how much you’d like to add to your pension. Visit pension tax relief to use our calculator.


Explore our Investment Times summer 2021 edition for more articles like this.

See all articles

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Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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