Lifetime ISA: the pros and cons
When former chancellor George Osborne announced the Lifetime ISA (LISA), he positioned it as a means of saving for both a first house deposit and for retirement. The pensions industry agreed that LISA represented an attractive retirement savings option for some younger self-employed individuals but raised concerns that employees might be tempted away from workplace pensions (auto-enrolment), losing valuable employer contributions in the process.
With further information on the LISA published recently, along with crucial detail on the exit charge, it’s now possible to provide a fuller analysis of the product’s advantages and disadvantages.
Valuable 25% government bonus
When you contribute into a LISA, you get 25% added. If you are committed to using this money for a first house purchase or leaving it until age 60, this is very valuable. If you pay in the yearly maximum of £4,000, this becomes £5,000 once your LISA provider claims your government bonus. This is the same boost individuals who are basic rate taxpayers get on personal contributions to a pension.
How the exit charge works
There is a major drawback for those who might choose to access this money before the age of 60. Any ‘ineligible’ withdrawals incur a penalty of 25%, slashing your overall savings.
You might think this means the 25% bonus you got at outset is just taken back. But in practice, the 25% penalty is based on the amount after the bonus and investment growth, which means if you decided to access all your cash after one year, ignoring investment growth you’d only get back £3,750. Effectively, you’ve paid an additional penalty of £250 for accessing your money early.
Further, the 25% penalty is applied to the funds withdrawn including any interest or investment growth. Those saving for a first home deposit are likely to want to invest safely in a cash based fund rather than in stocks and shares that could go down as well as up. In today’s low interest rate environment, you’d be lucky to get more than 1% interest on a cash ISA, so the £250 additional penalty could easily wipe out five years of interest.
Comparing with the current Help to Buy ISA
For those saving for a first home, the LISA will in time replace the Help to Buy ISA (H2B) and allows higher contributions to be invested (under H2B the maximum is £200 per month after an initial deposit of up to £1,200 and the maximum bonus is £3,000). However, the H2B ISA receives its bonus only on at the point of first house purchase and there’s no penalty if the individual accesses their savings for other reasons. Those not saving above the H2B limit may prefer to keep paying into their existing plan to avoid the potential of an exit penalty within LISA. While H2B ISA funds can be transferred into LISA, this needs to be considered carefully remembering it immediately introduces the possibility of an exit charge if money is subsequently used other than for a house purchase.
Comparing LISA with personal and workplace pensions
If you’re considering your retirement savings options then it’s worth remembering that under the government’s automatic enrolment policy, all employees earning above £10,000 a year are enrolled into a workplace pension. Employers are required to contribute a minimum amount and employee contributions also benefit from a government top-up in the form of ‘tax relief’. For a basic rate taxpayer, the government top-up is equal to the 25% LISA bonus but the employer contribution can be much more generous. It’s not uncommon for the employer to ‘match’ the employee contribution after government top-up. This could mean every £800 an employee pays into their pension from take-home pay could become £2,000 overnight. While some of the income taken from a pension is subject to income tax, workplace pensions can still represent much more value than LISA for retirement savings
The self-employed don’t benefit from auto-enrolment and there is no ‘employer’ to add contributions. So for them, LISA will offer an attractive alternative to current personal pensions. LISA is only open to those under 40 and self-employed individuals who are paying higher rate tax could find that pensions are still more tax efficient because of the more generous government top-up, equivalent to 66%, higher rate taxpayers receive on pension contributions.
LISA’s place alongside other savings vehicles
For individuals committed to saving for a first home, the LISA with its Government bonus will be attractive, although those saving within the H2B ISA limits may hold onto these to avoid the chance of an exit penalty if they withdraw funds for other reasons.
Employees saving for retirement will almost always be better off using workplace pensions where they also benefit from employer contributions. Younger basic rate self-employed individuals may find LISA an attractive alternative to personal pensions.
Whatever your medium to longer-term savings objectives, it always makes sense to have some rainy day money which you can access immediately and penalty free. Neither pensions nor LISAs offer this.
So despite LISA being positioned by the former Chancellor as the solution to multiple savings objectives, for most people, it makes sense to have a range of different savings vehicles – a workplace pension, an ISA and for future first time homeowners a H2B or LISA.
Steven Cameron is pension director at Aegon