In his Budget statement last week, Chancellor George Osborne announced the introduction of a new Lifetime ISA from April 2017. His intention is clearly to get the next generation saving, but will he succeed, and what does the Lifetime ISA hint about the future of pensions?
The Lifetime ISA – how does it work?
The Lifetime ISA (LISA) will be available for 18-40 year olds from next April. Savers will be able to put aside up to £4,000 per year and have this topped up by the government by £1 for every £4 they put in. The government bonus will stop at the saver's age age 50.
Access is flexible enough, but comes with penalties. The LISA is intended as a savings vehicle for a house deposit, or for retirement. It will therefore be possible to withdraw funds for a house deposit for a house valued at up to £450,000 with no penalty at all. Also, when the saver reaches age 60, there will be no penalties when making withdrawals.
At any other time, if a withdrawal is made, then the government bonus plus any growth on the bonus will have to be repaid, as well as a 5% exit charge – pretty steep.
There’s a really good factsheet here, produced by the Government, all about LISA and how she’ll work.
A new kind of pension?
There was some strong indications before the budget that Mr Osborne might make sweeping changes to pension tax relief. This is seen as unfair as those paying the highest rates of tax (i.e. those earning more) receive the greatest level of tax relief when making pension contributions.
Just ten days before the budget, it was leaked that there would be no major changes to the pensions regime. It seemed that the Chancellor had come under a great deal of pressure from back benchers not to meddle there.
But I wonder if, in the Lifetime ISA, we may be seeing the shape of things to come.
Tax relief
A bonus of £1,000 added to savings of £4,000 is equivalent to 20% tax relief (£1,000 is 20% of the total savings amount of £5,000). This bonus will be added at the end of the tax year, unlike pension tax relief which is added throughout the year to each contribution.
Even if a 35 year old who wants to save into a LISA is an additional rate taxpayer, getting 45% tax relief on pensions, she'll only get the 20% bonus on her LISA. This sounds like flat-rate tax relief to me; something the Chancellor was supposedly going to introduce for pensions.
Could it be that LISA is paving the way for a new flat-rate system, limited to a maximum amount each year?
Early access
The Lifetime ISA is ostensibly intended as a savings vehicle towards house purchase and retirement planning. This dual role for the plan suggests that more flexible access might be allowed to pension plans in the future.
The government is apparently planning to consult on whether it should be possible to borrow from a pension, similar to how the American 401K schemes work, for certain eventualities. Whether this early access will be in the form of actual withdrawals or borrowing, the added flexibility will be attractive, as long as the terms are not too punitive.
Limited saving levels
Pension contributions are limited to 100% of your relevant earnings or £40,000 in any one year. LISA savings are limited to £4,000 per year to attract the government bonus, but the £4,000 limit falls within the larger overall ISA savings limit of £20,000 per year from April 2017.
£4,000 is clearly not enough for anyone adequately to provide for their retirement, so I wonder if in time the maximum contribution which attracts the government bonus might increase to something nearer the pensions annual allowance.
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The shape of things to come?
My gut feeling is that the government are testing the waters here. I think they may be getting us used to more accessible terms like ‘bonus' as opposed to ‘tax relief.' Pensions have a kind of mystique surrounding them that makes people think they are more complex than they really are. They also have had a bad rep thanks to the financial services making promises to pension holders that they ended up being unable to keep.
I wonder whether, by adopting the much more easy-to-understand ISA nomenclature, the government is trying to consign the idea of pensions to the past, at least for those under aged 40.
I do think that the new Lifetime ISA encourage people to save. I am always banging on about sucking up free money where it's on offer, and the new LISA, while not quite as attractive as a company pension, will, I hope, be a good way for many more people to get into the savings habit.
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