George Osborne’s new Lifetime ISA (LISA) has been hailed as a major boost to the saving prospects of the young and self-employed, so how will it work (and is there a catch?!)
The LISA is set to launch in April 2017 and will be available to the under 40’s only. Contributions will be limited to £4,000 each year and will be automatically topped up by the government by £1 for every £4 invested. Like the existing ISA (& pension) a LISA will benefit from largely tax-free investment growth.
Withdrawals after the age of 60, or for the purposes of purchasing a first home, will be free of tax. Withdrawals will also be allowed in other circumstances, however the government top up (& any growth on it) would be withdrawn and an additional 5% penalty would be levied.
How Does LISA Compare?
The LISA will certainly create more flexibility & choice for younger savers and in certain circumstances will be the preferred choice when investing for the longer-term. In other cases however, it may prove to be a somewhat confusing, or even financially damaging distraction.
The table below outlines the effective tax benefits of the main tax-advantaged savings products. It assumes in each case that the individual will be subject to basic rate tax (20%) in retirement.
|Product||Tax Relief / Saver’s Bonus||Tax Rate on Income||Net Cost||Invested||Receive||Gain|
|Pension (45% Taxpayer)||82%||20%||£100||£182||£155*||55%|
|Pension (40% Taxpayer)||67%||20%||£100||£167||£141*||41%|
|Pension (20% Taxpayer)||25%||20%||£100||£125||£106*||6%|
* Assumes 25% paid as tax free cash.
For younger savers who are not paying higher rates of income tax the LISA appears highly attractive, offering a tax break both upfront and in retirement (assuming of course that a future government doesn’t move the goalposts!) The flexibility to access these savings to fund a potential house purchase is a further advantage not afforded to traditional pensions.
However, while some young savers may be tempted to opt out of their employer’s workplace pension in favour of a Lifetime ISA, by doing so they could well be missing out on valuable employer contributions and NI savings, not factored into my analysis. They may also be encouraged to use all their savings to purchase property, ignoring the question of how their retirement will eventually be funded.
The headline figures I’ve quoted don’t paint the full picture in other ways too. Due to the personal income tax allowance, and the various income tax bands, it is unlikely that anyone would pay exactly 20% income tax in aggregate throughout retirement. Depending on individual circumstances the relative attractiveness of the LISA might therefore be either higher or lower than illustrated. Although it won’t be a major consideration for most younger people, the LISA (& regular ISA) form part of an individual’s estate for inheritance tax purposes, whereas pensions are exempt.
Higher earners, who are happy to tie up their funds until retirement, may well remain better off investing via a pension, but the LISA provides a useful additional option, particularly for anyone in danger of breaching either the annual or lifetime pension allowances.
In summary, I welcome the LISA, but it still remains to be seen how many companies will offer a flexible and cost-effective product, given the rather burdensome administrational practicalities. We must also hope that the LISA is not a Trojan horse that precedes the wholesale demise of the current pension regime.