It is of great interest and remains a challenge to simultaneously improve the compatibility and flame-retardant performance of lignin/epoxy resin (EP) composites. In this work, a polysiloxane-enwrapped phosphorus-containing lignin-based flame retardant (PHMS-lig-P) was prepared through reactions of lignin, PHMS and TCP to address this issue, with results showing significantly improved flame-retardant performance and comprehensive performance. The influence of PHMS-lig-P on the flame retardancy of EP was investigated by vertical burning test (UL-94V), limiting oxygen index (LOI), smoke density test and cone calorimeter (CC) test. The PHMS-lig-P/EP achieved a V-1 rating, and its LOI value increased to 25. 3%. The maximum smoke density (Ds, max) decreased by 83. 2%. Furthermore, pHRR, avHRR, and MLR of PHMS-lig-P/EP decreased by 37. 5%, 22. 6%, and 25. 1%, respectively. In addition, the evolved gases and char residues were studied using thermogravimetric analysis coupled with Fourier transform infrared spectrometry (TG-FTIR) and scanning electron microscopy (SEM). The results certified the flame-retardant mechanism of PHMS-lig-P was attributed to the synergistic effect of lignin, phosphonate, and polysiloxane, producing a compact and cohesive char layer that acted as a physical barrier, limiting the transfer of heat and oxygen and preventing the spread of pyrolysis volatiles and flammable gases. Moreover, the flame-retarded epoxy resin possessed good dispersion uniformity in mechanical properties and insulation performance, showing good applicability.