I see at least two aspects to your question: can a retracted article, in general, be cited in other research; and can a literature review include a retracted article in its review?
Can a retracted article, in general, be cited in other research? YES. On this point, I have little to add beyond Ben's excellent answer. I disagree with those that think that only scholarly or only peer-reviewed articles should be cited in scholarly work. Anything can be cited, but especially if what is cited is not peer-reviewed, then the citing author is responsible to verify the validity of what they cite. (We should even be responsible to verify the validity of the peer-reviewed work that we cite, but because there is so much research out there, it is understandable that we generally trust the peer-review process to do this validation for us.)
Can a literature review include a retracted article in its review? YES. I want to be very clear that such an article is NOT part of the scholarly body of peer-reviewed literature--it has been retracted, so does not have that quality stamp. However, I strongly believe that a literature review should include grey literature--the body of scholarly research that is not peer-reviewed, and even when meaningful, high-quality practitioner articles or books. However, you need to be clear that if you cite grey literature (including retracted articles, in your case), you should bear the responsibility to appraise and validate the quality of such work that has not been peer-reviewed. For your readers, it would be irresponsible of you not to verify that the work you cite is valid, particularly if other scholars have not already done so (that is, through peer-review). In particular for a retracted article, you should definitely explicitly mention to your readers that it was retracted and that you are knowingly citing it anyways.
Finally, you asked, "is it ethical to work on the topic of this retracted paper"? You are free to work on the topic of any article, whether published or not, retracted or not. As long as you cite and acknowledge the source of original ideas, then you are fulfilling your ethical responsibility. If your concern is that the retracted article no longer has a standard scholarly citation, well there is a good question and answer on how to correctly cite a retracted article.