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Lifetime ISA vs Pension – which is best if you're self-employed?

Run your own business and don't know whether to save into a Lifetime ISA or a pension? Here’s what you need to think about.

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.

Running your own business and trying to balance the cash flows might mean saving for retirement isn't top on your priority list. But thinking about setting money aside now will allow you to continue to choose your own path, whenever you decide to stop working.

If you're put off by the idea of having to commit to regular payments, don't be. There are products that allow you to make flexible payments to suit your needs. This can be useful if you work for yourself. You can stop and start regular payments or make one-off lump sum payments depending on how well your business is doing.

If you're looking for a tax-efficient way to save for the future, in addition to investment accounts that work throughout your life, like ISAs, you'll typically have two retirement accounts to choose from. Using both can also complement each other. A pension, like a Self-Invested Personal Pension (SIPP), and a Lifetime ISA (LISA).

Although they both offer flexible contributions, there are a number of things to consider like your age and tax position. Comparing the benefits of both can help you decide the best course of action.

This article isn't personal advice. If you're not sure what's right for your situation, please seek advice. Pension and tax rules can change, and benefits depend on your circumstances. Different tax rates and bands apply for Scottish taxpayers.

Earn £50,270 or more? Here's why you should consider a pension

A pension (like a SIPP) is a great way of saving for retirement while reducing the tax you pay. Any money in a pension is free from UK income and capital gains tax. And you'll get a boost from the government in the form of tax relief on anything you pay in.

If you pay tax at a higher rate, this boost could be up to 45% (up to 46% for Scottish taxpayers). This is more than you'd get from a LISA, which offers a bonus of 25% on up to £4,000.

Let's say you pay tax at 40%, you could be entitled to tax relief of up to 40% on pension contributions. If you paid £4,000 into a LISA, you'd get £1,000 in government bonus. Whereas if you'd paid this into a pension, you'd get up to £2,000 in tax relief.

The LISA 25% bonus is effectively the same as a basic-rate taxpayer's pension tax relief entitlement of 20% (in that 20% in tax relief on £4,000 would boost it to £5,000, which is an increase of 25%). But as a higher earner you can claim back more in tax relief via your tax return, making pension contributions more tax efficient.

Try our tax relief calculator

Your pension is for your retirement, so you can't normally take money out until age 55 (rising to 57 in 2028). When you can access it, up to 25% is usually tax free, the rest is taxed as income.

Lots of higher-rate taxpayers will be basic-rate taxpayers in retirement. This means you'd get higher-rate tax relief on anything you pay into a pension. Then after your tax-free cash (usually up to 25% of your pension value), you'd only be paying basic-rate tax on anything you withdraw.

More on pensions

How much can I pay into a pension each tax year?

You can normally pay in as much as you earn and receive tax relief, although there's an annual allowance which is £40,000 for most people. This might be less if you've already accessed your pension or you’re a higher earner. If your earnings are less than £3,600, you can still make contributions of up to £3,600 (including the tax relief).

There are different methods for working out how much you earn, and therefore how much tax relief you can receive on personal pension contributions if you work for yourself.

If you're a sole trader, this will be the profit before tax which you declare to HMRC in the current tax year. If you work for your own limited company, this will be any salary you're paid, plus any taxable benefits, before tax. Dividends, investment income, and income from property you own don't generally count as earnings.

More on contribution limits

Download our essential guide to pensions for business owners

What if I want to pay in through my company?

If you own your own limited company, you could think about making an employer contribution to a pension. The contributions can usually be treated as a business expense so you can offset corporation tax and reduce your company's tax liability.

Employer contributions will count towards the annual allowance (which is £40,000 for most people), but aren’t limited to earnings. Income tax relief is only available on personal contributions, not employer contributions.

More on employer contributions

Under 40 and earn less than £50,270? Here's why you should consider a LISA

A LISA is another tax-efficient way to save for later life or to help you buy your first home. You can open an account between the ages of 18 and 39, although once you open it you can pay in until you're 50. Like a pension, your money can grow free from UK tax.

Here's how it works. You get a 25% bonus from the government on anything you pay in up to the £4,000 annual allowance – meaning you could receive a bonus of £1,000 each tax year. The key difference is any income you take will be completely tax free if withdrawn after age 60, unlike any money from a pension where usually 25% is tax-free.

Let's say you're a basic-rate taxpayer, and you pay in £4,000 into a LISA for 10 years. You'd have a pot worth £50,000 which you could withdraw entirely tax free from age 60. If you'd paid that money into a pension, you'd normally only get up to £12,500 tax free, the rest would be taxed as income.

This is just an example, it doesn't account for any growth if your investments performed well. Investments can fall as well as rise in value, so you could get back less than you invest.

A LISA also offers more flexibility than a pension. You can take money out whenever you need it but there is an early exit penalty. Be aware though, savings outside a pension (like in a LISA) could affect your entitlement to means-tested state benefits.

More on the LISA

When can I take money out and what's the early exit penalty?

You can withdraw from age 60, or to buy your first house, and this will be completely tax free.

If you withdraw money early, there's normally a withdrawal charge of 25%. This means you could get back less than you put in.

It's also important to remember your retirement could last decades, so you need to make sure you've got enough saved. Tapping into your retirement savings early means you could risk falling short in later life.

If you're over 40 and earning less than £50,270, don't ignore your pension

Paying into a pension is still one of the most tax-efficient ways to save for retirement. As a basic-rate taxpayer, you can pay in up to your earnings and benefit from 20% tax relief. There's also an annual allowance which is £40,000 each tax year for most people.

Let's say you wanted to pay in £10,000 into a pension. You'd only have to pay £8,000 and the government would add £2,000.

Then when you take money out from a pension (from age 55, rising to 57 in 2028), up to 25% is usually tax free and the rest is taxed as income.

More on pensions

What if I want to make payments from my company?

You can make employer contributions to a pension to offset how much corporation tax your company will pay. These payments won't be limited by your earnings, but count towards the annual allowance which is £40,000 for most people.

It doesn't have to be one or the other

Both pensions and LISAs have advantages and disadvantages. It's important to think about your own objectives and personal circumstances when deciding what's right for you. It also doesn't have to be a case of choosing one account over another, but at certain stages of your career one might be more useful.


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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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