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LISA: a new kid on the block
The 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. You can save up to £4,000 each year until you are 50, and the Government will automatically add a 25% bonus on top. Like the existing ISA (and pension) a LISA will benefit from largely tax-free investment growth.
Withdrawals after the age of 60, or before that age to buy a first home, will be free of tax. Withdrawals will also be allowed in other circumstances, but the government bonus (and any growth on it) would be withdrawn and an additional 5% penalty would be levied, so this means that your savings are tied up and can only be used to purchase a home or as a means of saving for retirement
How Does LISA Compare?
The LISA will certainly be a good choice for under-40s saving for their first home, and in certain circumstances will be the better option when investing for the longer-term. In other cases however, it may prove to be a somewhat confusing, or even lead to you losing out financially.
The table below outlines the effective tax benefits of the main tax-advantaged savings products. It assumes in that the individual will be subject to basic rate tax (20%) in retirement.
| Product | Tax Relief / Saver's Bonus | Tax Rate Paid on Income | Net Cost | Invested | Receive | Gain |
|---|---|---|---|---|---|---|
| ISA | 0% | 0% | £100 | £100 | £100 | 0% |
| Pension (20% Tax payer | 25% | 20% | £100 | £125 | £106* | 6% |
| Lifetime ISA | 25% | 0% | £100 | £125 | £125 | 25% |
| Pension (40% Taxpayer) | 57% | 20% | £100 | £167 | £141* | 41% |
| Pension (45% Taxpayer) | 82% | 20% | £100 | £182 | £155* | 55% |
For younger savers who are not paying higher rates of income tax the LISA is a good option, offering a tax break both upfront and in retirement. The flexibility to access these savings to buy your first home is a further advantage not available with traditional pensions.
However, while some young savers may consider opting 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 that are not factored into this table. And if they use all their savings to purchase property, they will still have to consider how their retirement will eventually be funded.
There are other things to consider 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. The relative attractiveness of the LISA might therefore be either better or worse than shown here, depending on your circumstances. Although it won’t be a major consideration for most younger people when it comes to inheritance tax, the LISA (and regular ISA) form part of an individual’s estate, whereas pensions do not.
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 handy further option, particularly for anyone who might surpass either the annual or lifetime pension allowances.
In summary, I welcome the LISA, but it still remains to be seen how many companies will deal with it, given the rather heavy administration involved in setting LISAs up. Let’s hope the LISA is not a precursor to the wholesale demise of the current pension system.
* Assumes 25% paid as tax free cash.
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Ian Thomas is authorised and regulated by the FCA. This article is intended to provide helpful information of a general nature and does not constitute financial advice.
