Will LISA kill pensions?
Guest blog by David Pugh, managing partner, Lemonade Reward
The recently launched Lifetime ISA (LISA) is designed to help under 40s (18-39) purchase their first home or save for retirement. While I applaud the introduction of any tax-free saving platform that rewards savers with bonuses, I am not convinced this latest addition to the ISA portfolio, is as some describe, a credible alternative to pensions.
There’s already confusion over the account’s purpose – is it for first-time-buyers or those wishing to save for retirement? Surely such contrasting savings aims require different investment strategies?
Many financial service providers have yet to commit to offering a LISA, frustrated at the last-minute selling guidelines from the financial regulator and sluggish final detail feedback from the tax authorities. This in turn has prevented potential providers making changes to technology, impeding their product launch.
For those, however who are offering a LISA, there are stark differences between this and a pension and it’s important people understand what these are before making decisions about their pension provision, particularly if enrolled in a workplace scheme.
ISAs are widely recognised as a great place for tax-free savings. The individual tax-free limit is £20,000 a year and this can be split between cash and stocks & shares ISAs. A LISA can be cash or stocks & shares based and for every £4 saved, the Government will add £1 (worth up to £1,000 a year).
The first bonus is payable at the end of the 2017/2018 tax year and after this it will be paid monthly, up until the saver is 50. A maximum of £4,000 a year savings are eligible for the 25% top-up and in order to receive this, funds must be used for a house purchase or held until the saver is 60. If they’re used for anything else, there’s a 25% exit penalty, which not only loses the bonus, but it could reduce the overall savings amount too.
Employees aged between 22 and the State pension age, earning over £10,000 a year, must be automatically enrolled into a workplace scheme (workers earning less than this can also opt in to receive some employer contributions, as can those aged 16 to 74).
Employers also have an obligation to make pension payments, contributing a percentage of qualifying earnings. National Insurance relief on employers’ pension contributions means money paid into an employee’s pension goes much further than it would if it was channelled into a salary, which after tax and National Insurance deductions could be paid into another savings vehicle.
A third top-up comes from the pension provider running the workplace scheme; tax relief is claimed from HMRC at a rate of 20% and then added to the pot. A triple top-up, courtesy of the employer and Treasury.
LISA bonuses are added at the end of the first tax year and then monthly after this, meaning the compound interest is likely to be lower than with pensions. Every contribution into a pension is instantly topped-up and interest added immediately, growing the pot faster.
Only savings of £4,000 a year are eligible for the LISA top-up, whereas the pension top-up limit is £40,000 for most people.
Although the 25% LISA bonus is equivalent to pension tax relief of 20% for basic rate taxpayers, it is only half what higher rate tax payers – who receive 40% tax relief on their pension contributions – can achieve. And this is before employer contributions and the pension provider top-up are taken into account.
While money in a LISA can be withdrawn tax-free at any time, bonuses will only be paid at age 60, (or on the purchase of a property). With pensions, 25% of the pot can be taken, tax-free, from 55 onwards. Tax on the remainder is payable dependent on the withdrawal rate.
Addition not replacement
For those who question why bother with pensions, I don’t believe the level of bonuses or growth predictions of a LISA will match the employer/HMRC contributions and long-term growth that can be achieved with a pension. As former pension minister Baroness Ros Altman said: “Opt out of a workplace pension and you lose the chance to double your money.”
Workers who do opt out will not only lose their employer contributions, but they’ll lose the tax benefits too. This is why LISAs will not kill pensions. It is an additional tool, not a replacement, and this is why I concede a LISA provides a great way of building additional retirement funds, particularly for basic rate taxpayers and the self-employed who do not have access to workplace schemes.