- Lisas are good ways to save for retirement as well as for buying homes
- Isas in general are a good way to save for retirement if you have used up your pension allowances
- You can leave your Isa to your spouse IHT-free
What are the benefits of a lifetime Isa?
Lifetime individual savings accounts (Lisas) can be used to build up funds for a first home but also for retirement.
You can open a Lisa between 18 and 40 and make contributions until 50. You can contribute up to £4,000 a year with the government adding a 25 per cent bonus.
You can withdraw money from a Lisa before 60 to buy a first home or because you are terminally ill with less than 12 months to live. If you withdraw before then for other reasons you pay a charge of 25 per cent of the withdrawal value. This includes if you buy a first home worth more than £450,000. You also need to buy the property at least 12 months after your first Lisa payment. Nevertheless, if you are under 40 it could be worth opening a Lisa to grow funds towards a property or retirement.
If you already have a Help to Buy Isa it could be worth transferring it into a Lisa. With Help to Buy Isas you can only invest up to £2,400 a year after the year you opened it, and can only put the money into cash. If you have both a Help to Buy Isa and a Lisa, you can only use the government bonus from one of them to buy your first home.
Do also consider a Lisa for retirement savings. “If you’re employed, a workplace pension should be the first port of call because your contributions trigger payments from your employer,” says Sarah Coles, senior personal finance analyst at Hargreaves Lansdown. “However, once you have taken full advantage of all the contributions your employer is willing to pay, consider paying into a Lisa.”
For basic-rate taxpayers the Lisa government bonus of 25 per cent has the same impact as the 20 per cent tax relief on pension contributions, due to how they are calculated. Withdrawals from Lisas after 60 are tax free, whereas some pension income is likely to be taxed. “For basic rate taxpayers who will pay tax in retirement, a Lisa is worth considering for the next chunk of your retirement savings,” says Coles. “For self-employed people who don’t get employer pension contributions, it’s worth considering from the outset.”
Higher or additional rate taxpayers get tax relief on pensions contributions of 40 per cent or 45 per cent, respectively, which is significantly higher than the Lisa bonus. “Tax relief on the savings at 40 per cent or 45 per cent is beneficial, especially if the income is drawn out gradually with 25 per cent tax free and 75 per cent taxable income,” says Kay Ingram, chartered financial planner.
Those with taxable income in retirement of less than £50,270 or £43,430 in Scotland would pay tax at a lower rate than the rate of relief given on their pensions contributions.
How can you use Isas in retirement planning?
Although pensions are more tax efficient than most Isas for accumulation, pension withdrawals are likely to be taxed whereas withdrawals from Isas are not.
You should prioritise a workplace pension scheme to get the employer contributions. However, if you are a basic rate tax payer, after you have contributed enough to your pension to get the maximum employer contribution, your next port of call should be a Lifetime Isa, if available.
If you have used up your pensions annual allowance, Isas are the next option.
The pensions annual allowance is usually £40,000 or the value your relevant earnings, whichever is less. However, this is reduced in certain situation. if your threshold income is above £200,000 and adjusted income is above £240,000, your annual allowance is reduced by £1 for every £2 of adjusted income above this level. The taper stops at adjusted incomes of £312,000, so if you earn this amount or more you can only put up to £4,000 a year into pensions without incurring a tax charge.
Also, if you draw more from a defined contribution pension than the tax-free cash entitlement, typically 25 per cent, you trigger what's called the money purchase annual allowance and only receive tax relief on pensions contributions of up to £4,000 a year.
If you do not have relevant earnings, for example, because you do not work or get income from rents or dividends, you can only put up to £2,880 a year into a pension, which after tax relief comes to £3,600.
In these situations, an Isa is a good way to make additional tax efficient retirement savings.
Isas can play a role too if you have used up your pensions lifetime allowance. You pay a charge on money drawn from pensions over the value of lifetime allowance. This is 25 per cent if it is taken as income, on top of any income tax, or 55 per cent if it is taken as a lump sum. There is no lifetime limit on Isa savings.
If you have Enhanced or Fixed Protection for your pension, you are given a larger lifetime allowance. But a condition of this that you do not make any more pension savings. So again, for tax efficient saving you could instead use an Isa.
Typically, financial planners suggest first using up assets outside tax wrappers and secondly Isas in retirement, before turning to your pension.
Drawing from Isas before pensions makes particular sense if you hope to leave assets to children or other beneficiaries. You can pass on Isas to spouses or civil partners tax free but if given to other beneficiaries they may incur inheritance tax (IHT) (see below). But personal pensions can be passed onto beneficiaries without IHT. If you die before 75 beneficiaries can withdraw from the pension tax free and if you die after 75 their withdrawals are taxed at their marginal income tax rate.
Isas could be a way to plug the gap until pensions kick in. You can access adult Isas at any age, excluding Lisas. But you cannot access private pensions until 55 and this rises to 57 from April 2028. You cannot currently claim your state pension until 66 and there will be a phased increase to 67 between 2026 and 2028. This is likely to rise to 68.
Using Isa savings in combination with pensions can be a more tax efficient way to draw a retirement income. After you have taken your tax free lump sum from a pension, usually the first £12,570 of income you receive each year is tax free because it falls into your Personal Allowance. Income above that is taxed at your marginal rate. If you are retired you could take income from pensions, including any state pension, of up to £12,570 each year and then take further amounts from Isas tax free.
Those seeking retirement income from Isas should not necessarily invest them in high yielding equities. “The problem with this strategy is that you’re massively restricting the stocks you can hold to high-paying divided stocks only,” says Anthony Villis, managing director of First Wealth. “You often end up with a very home biased portfolio because the UK stock market is unusually high in terms of the dividends it pays. A better alternative could be a low cost international portfolio of equities via a tracker fund, from which you sell down units to create income.”
He also cautions against de-risking Isas at the point of retirement and switching into bonds and cash. “This will restrict the future growth potential and your Isa will lose pace to inflation,” he explains. “You could live for another 30 years plus so you need your assets to grow in real terms.”
What happens to your Isa when you die?
Transfers are not usually subject to IHT when you leave an Isa to your spouse or civil partner. With deaths after December 2014, the inheriting spouse can apply for an additional permitted subscription. This is a one off additional Isa allowance for the surviving spouse on top of their own. To receive this you must not have been separated at the time of death.
With deaths after 6 April 2018 the Isa becomes a continuing Isa until the administration of the estate is completed, the third anniversary of the death or the closure of the Isa due to all funds being withdrawn. The additional permitted subscription is the higher of the value of the Isa at the date of death or date it ceases to be a continuing Isa.
So, for example, if the Isa is worth £75,000 at closure the surviving spouse would have a total Isa allowance at that point of £95,000.
For deaths before 6 April 2018, the additional permitted subscription is the Isa value at the date of death.
“If the deceased person held several Isas with different providers the surviving spouse has an additional permitted subscription allowance across multiple providers,” says Villis. “You can transfer your additional permitted subscription to another provider if you did not want to use it with the surviving spouse’s provider, and use it in one go or in separate lump sums.”
The inheriting spouse can apply for the additional permitted subscription from the date of death. Cash subscriptions must be made within three years of the date of death or up to 180 days after the administration of the estate is complete, whichever is later. But an additional permitted subscription made as stock, for example because the inheriting spouse does not want to sell the funds and shares held in the deceased's Isa, must be completed within 180 days of the assets being distributed.
The spouse can keep the inherited Isa assets with the deceased’s provider, transfer the money to their own Isa provider, or open a new Isa and transfer the additional permitted subscription there. However, they need to ensure that the Isa provider they have in mind accepts additional permitted subscription allowances. If they want to transfer their late spouse's Isa investments as they are, rather than selling them and transferring as cash, they can only transfer them to an Isa offered by their late spouse's provider.
Even if an Isa is not left to a spouse they can still claim the additional permitted subscription. However, if you inherit a Lisa you can only transfer up to £4,000 per tax year into another Lisa, though can transfer excess funds into other types of Isas.
To make things easier for your spouse, ensure that they have the policy numbers and provider details, and know the process. Isa providers typically request details such as the deceased’s date of birth and death, the date of the marriage or civil partnership, and the deceased’s National Insurance number.
“If you hold several Isas, consider consolidating them as this would make the process simpler for your spouse after your death,” adds Villis.
If you leave the Isa to anyone else it falls into your estate for IHT purposes.
If the Isa is invested in Aim-traded companies which qualify for business relief, and you have held them for two years or more, these may not form part of your estate for IHT purposes. The status is assessed at the point of probate. However, Aim shares are high risk and not all qualify for business relief.
To ensure the efficient transfer of your Isa after you die, Villis says to make provision for this in your will so that the executors are aware of your wishes.