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The error of investing in the lifetime ISA

Lifetime ISA disaster 


In short, put your money into your workplace pension and not a Lifetime ISA. Why? Because the returns are so much better in a workplace pension. You might be thinking that you heard that the Lifetime ISA is paying a 25% bonus on top of any money that you put in when you come to retire - surely that's better than the returns that you get in a workplace pension?

Compound interest versus a nominal return


As indicated in the title to this section the answer to the above question is likely to be incorrect for a couple of reasons and one of these is related to compound interest. 

The Lifetime ISA promises to pay out a 25% return on top of your contributions. The 25% return is only accessed once you either choose to buy a house less than £450,000 or when you reach the age of 60. On the other hand, the workplace pension invested in (for instance) a safe asset such as some bonds that pay 1%-2% per year. The interest compound over time such that your effective return is much higher over the 30-40 year period in which you're invested. The Lifetime ISA just pays 25% as a one off. The pension earns interest after the first year, then in the second year your earn that interest again but also interest on the previous years interest and so on and so forth.

Government payments


In addition to the miracle of compound interest the government will likely give you more 'free money' via your pension than from a lifetime ISA. The government will reduce your tax bill by 20pence for every 80pence that you put into a work place pension if you are a basic tate tax payer. If you're a higher rate tax payer this is even better - 40pence is saved in tax for every 60pence put into a pension.

Company free money 


Furthermore, in a workplace pension the reality is that you double your money day one due to your Company matching your payments. That's a 100% return day 1 before you've even looked at the interest from the fund or from the tax savings. Why would anyone choose a lifetime ISA over a workplace pension.

Possible reasons for putting into a lifetime ISA 


Genuinely, I can only think of a couple of reasons as to why you might put your money into a lifetime ISA. Suppose you'd maximised our pension contribution allowance of £40,000 per year. Whilst this is unlikely for most people who don't even earn that much you may wish to consider the lifetime ISA for your excess funds.

Alternatively, you may not be concerned about your retirement right now - mistakenly! Instead you focus on buying your first property and reason that it will definitely be below £450,000. In these circumstances you may wish to consider the lifetime ISA.

Should I get a lifetime ISA?


Unless you've got some particular circumstances most people should be avoiding this product and instead focusing on the good old pension! You can thank me in the long run.

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2 comments

Dave K said...

I'm afraid I think you're wrong about compound interest. The government state that "The bonus will be paid into the Lifetime ISA at the end of each tax year, so that savers will also benefit from tax-free growth on the bonus from the time it is added." I.e. at the end of each tax year the 25% will be added and compound interest will accrue to the bonus AS WELL as the contributions made. Of course there will be a loss over the months until the end of the tax year, but that is all.

Also, your company may double your money, but many companies will only match the amount that they are required to by law. In my case only 1% of taxable income, any contributions after that do not apply. You and I have benefited a great deal from employers matching contributions (I used to have a great employer for this), but not everyone does.

A Lifetime ISA may reduce your tax liability as well over a lifetime. Although you get tax relief on paying into your pension, you will get taxed when it is withdrawn (if your pension income is over your personal allowance). You won't get taxed on withdrawals from the Lifetime ISA.

There are pros and cons to both products, but it is not as straightforward as you suggest.

Mr. Moneybanks said...

Very fair points. But I would argue that the tax benefits alone of putting into a pension should more than outweigh the benefits from contributions to the new LISA