Which retirement savings vehicles are best for wealthy millennials?

So what options are available to you? There are two products designed for retirement saving that allow your savings to grow tax-free and that qualify you for a generous financial contribution from the government in the form of tax relief or a bonus. The first is a pension plan of which there are two types: workplace pensions and self-invested personal pensions (Sipps), and investors can use either or both to save. The second is a lifetime individual savings account (Lisa), which is similar to a pension in that the government makes a contribution to the amount in your pot at no cost to you. Savings and investments within an ordinary Isa also grow tax-free, but there is no contribution from the government.

To begin with says Andy James, head of retirement at Tilney, “if the workplace pension is on offer then take that because you’ll get employer contributions”.

All employers must now provide a workplace pension, and most employees will be enrolled automatically. As of April 2019, the minimum contribution the employer must put into each employee’s pension is 3 per cent of the person's earnings, while employees must contribute 5 per cent. However, “a lot of employers are more generous and pay more than the minimum”, says Sarah Coles, personal finance analyst at Hargreaves Lansdown. Provided that you increase your contribution, many employers will increase theirs too, in what is known as contribution matching. “Many go up to 10 per cent,” says Ms Coles. 

Besides any employer contributions into your pension, any payments you make up to a certain amount are entitled to receive tax relief, so money that would have been paid as tax is diverted into your pension pot. Basic-rate taxpayers in England and Wales receive 20 per cent tax relief, higher-rate taxpayers receive 40 per cent relief and additional-rate payers 45 per cent. The rates in Scotland range from 19 per cent to 46 per cent. Relief is available on up to £40,000 of earnings a year, or 100 per cent of your earnings if lower than this, but for those whose earnings exceed £150,000 a year that annual allowance is tapered away to as little as £10,000 a year.

Another benefit of a pension is that if an employer offers a salary sacrifice arrangement, whereby part of your earnings exchanged for pension contributions, the employee can save on tax and national insurance. “Salary sacrifice is always a good idea because you don’t pay tax or national insurance on the portion of pay you give up,” Mr James says. But this can work against you: “As it reduces the level of your earnings, it can put you in a lower threshold for a mortgage,” he notes.

So how do Lisas compare with pensions? Lisas offer a flat rate 25 per cent bonus from the government, depending on what you put in, up to £1,000 a year. Their big advantage is flexibility because they are designed to allow you to save for retirement and/or a first home – an important consideration for most millennials. However only individuals aged between 18 and 40 can open an account. If you fall into this age bracket, you can save up to £4,000 each year in your Lisa until the age of 50. This is significantly less than for a pension, into which individuals can contribute up to £40,000 a year until the age of 75, subject to a lifetime cap of £1,055,000 for most people currently.

There are two types of Lisa: a cash Lisa and an equity Lisa. “If you plan on using your Lisa money to buy a house in the next five years,” Ms Ingram says, “then it makes more sense to put money into a cash Lisa. If you need to invest the money for more than five years an equity Lisa can give you better returns. If you want growth that matches house prices over the long run then equity Lisas are better too.” There are currently only three cash Lisa providers: the Newcastle Cash Lifetime ISA, Nottingham Building Society and Skipton Building Society.

You can only withdraw the money from a Lisa to buy a first home. Otherwise you have to wait until age 60 to access it without penalty, whereas the minimum age you can access your pension is 55. For individuals who want to retire, go part-time or want to make a career change, this five years can make a big difference. If you withdraw Lisa money before age 60 other than to buy a first home, there is a penalty of 25 per cent of the value of the amount withdrawn. “This will claw back the bonus paid by the government and a chunk of the individual’s own savings too,” Ms Ingram says.

Ms Coles notes that: “At different times in your life you’ll have different priorities and at some point that might be getting on the property ladder. For individuals who don’t want a property worth more than £450,000, a Lisa is a good option. Once on the property ladder, they can look at rediverting that money into a pension.”

But Ms Ingram believes young individuals should focus on putting money into their pension because while interest rates are low, taking on a larger mortgage with a view to paying this off later could be a good bet. “The tax-free lump sum can be used to pay off the mortgage later and will have benefited from more tax relief and employer contributions than the 25 per cent boost offered by the Lisa,” she says.

For those who currently have no plans to use money in a Lisa for a first home, Mr James recommends they put money into a pension first and then the Lisa “because if you change your mind and take money out for a house purchase, then you need to make up that sum and the problem is that due to compounding, money you put in 10 years ago would have grown a lot. You have to put a lot more in to catch up to get your retirement pot back.”

However, Lisas offer an advantage when you are withdrawing the money. With a pension, only 25 per cent of it can be drawn down tax-free. The other 75 per cent will be liable to income tax even up to additional-rate tax. On the other hand, all money paid out from a Lisa is tax-free.

But as Mr James says: “It is impossible to know what rate taxpayer you will be in your retirement.” For forward-planning wealthy millennials, it's also worth noting that the Lisa will form part of your estate and could be liable to inheritance tax, while pension pots are usually exempt from inheritance tax, although the recipients may have to pay income tax.  

For wealthy individuals who can save more, Mr James says: “The first thing is, if a workplace pension is on offer then take that because you get employer benefits. Then for the vast majority the next thing would be to get a Lisa and max that out and then if there’s anything left on top of that pay into a Sipp.”

Sipps

With a Sipp, you choose the provider, and when and how you invest in it. You choose what to invest the Sipp in, although it is possible to have them run by a financial adviser or wealth manager. You can choose a full Sipp, which would allow you to invest in a fuller range of underlying investments such as commercial property, or you can opt for a low-cost Sipp which would typically only allow shares, funds, ETFs and investment trusts. 

You can contribute to a Sipp via regular deposits or one-off payments. But charges and the minimum amount you have to invest in Sipps vary across providers, so it's essential to shop around to find the best one for you. You also pay two sets of fees: those for the Sipp wrapper itself, and those relating to the investments you hold within it, for example dealing charges and/or fund management charges. There may also be exit fees.

Unlike workplace pensions, Sipps do not usually get employer contributions, but some employers will do this. You will be entitled to tax relief as described above and the fund will accumulate free of income or capital gains tax. Like a workplace pension you can withdraw up to 25 per cent tax-free, the rest is subject to tax. It is a great way to save money to leave for beneficiaries, though, because it can be inheritance-tax-free, provided you keep the money in it invested.

Ms Coles advises that: “When you get to retirement it makes sense to have a guaranteed income to cover basics, so use your drawdown and an annuity from your pension for that. Then use additional savings from vehicles like a Lisa, which provides tax-free income to cover other things like holidays.” A good general approach is to make sure you have enough from your pension and state pension to cover the basics and then use other vehicles for additional costs.

Source: Bestinvest, Pensions Advisory Service, IC * 19-46 per cent in Scotland