Paying money into an ISA has all changed this month with the advent of the new lifetime individual savings account or LISA.
If you are a UK taxpayer, the ISA upgrade opens some new retirement savings possibilities – but they come with some pitfalls.
If you are under 40 years old, you can open a LISA and pay in up to £4,000 a year, which is considered part of the annual ISA allowance of £20,000.
The bonus is the government will top up your contribution by 25% or up to a maximum £1,000 a year.
But the tax benefits are withdrawn unless the cash is spent on buying a home or goes towards funding retirement once reaching the age of 60.
LISAs lose against pensions because higher rate taxpayers do not gain tax relief at 405/45%, but basic rate taxpayers may gain because their savings are topped up at 25% instead of 20%.
For them, the trade-off is if having to wait until 60 is worth the extra top-up cash, as pension cash is available from the age of 55.
Inheritance tax is a big issue for ISA savers as their money is not excluded from an estate when inheritance tax is calculated, but unspent pension cash is.
No tax is likely if the pension saver dies before they are 75, while the beneficiary is likely to pay income tax on their inheritance if the pension saver dies after their 75th birthday.
The government has gone some way towards remedying this by letting a surviving spouse recycle their deceased partner’s ISA savings through another ISA.
Another tax issue in the ISA v pension debate is tax on drawing cash.
Savings as a bank account
Any money coming out of an ISA is free of income and capital gains taxes, while pension benefits are bundled as 25% of the fund tax-free and the rest attracting income tax at the saver’s marginal rate.
For many ISA savers, the attraction is instant access to their money without tax.
Savers should think about an ISA as their own bank account. Sensible savers will have at least the equivalent of household spending for six months in their ISA as rainy day cash in the event of losing a job or being unable to work.
Any cash balance on top of this can be borrowed for big purchases instead of taking cash at high interest rates from a bank or credit card provider, but the borrower should have the discipline to pay the full amount of the money back each month.