Daniel Stevens looks at whether the new tax advantaged ISA can really replace traditional pension savings.
A new type of savings account – the lifetime ISA (LISA) is now available (from 6 April 2017). The LISA was intended to provide an alternative way of saving for retirement, but is that really realistic?
Workings
The LISA is available for anyone aged 18-39 - you can’t open one from your 40th birthday onwards. Once opened, the saver can put up to £4,000 per year into the account, and have it topped up by a tax-free 25% bonus. This is the equivalent of basic rate tax relief that is given on traditional pension contributions; however, if the saver is a higher or additional rate taxpayer, no further relief can be claimed on LISA savings.
These matched bonuses can be paid up until the saver attains the age of 50 (so maximum bonuses of £32,000), and the money can then be withdrawn tax-free once the age of 60 is reached. If the funds are withdrawn before this, a penalty of 25% will be levied. This is applied to both the savings and bonus (as well as any growth), so can be punitive.
Example: Early withdrawal charge
You open a LISA and contribute £4,000 for two years. There is no growth, so after two years there is £10,000 in the account. You need the money for emergency home repairs and withdraw it.
You are charged £2,500 – meaning you get back £500 less than you put in! This is essentially a 5% penalty for the early withdrawal.
Withdrawing
There are occasions where money can be withdrawn with no penalty or loss of bonus before the age of 60:
- where it is used to help buy a first UK home – provided that home is mortgaged and is not worth more than £450,000 (regardless of where it is located). There are some restrictions on this – for example, you can never have held an interest in residential property before – even (say) a joint share in a property that was inherited and then sold; and
- the account holder has been diagnosed with a terminal illness and has a life expectancy of less than one year.
This slight increase in flexibility may encourage some lower level savers to use a LISA over a pension.
Worthwhile?
To specifically address the isolated point about whether a LISA is a credible alternative to pension savings, the answer is likely to be ‘no’ in most cases. Even if the account holder is a basic rate taxpayer (i.e. so the tax relief is essentially the same as a pension), the fact that savings can only be made for a maximum of 32 years means that the value is limited.
This doesn’t mean that the LISA should be disregarded though – using it alongside a pension scheme is probably the most likely way it will be utilised. Consider, for example, an executive who always uses his annual allowance of £40,000 each year – opening a LISA will allow additional tax advantaged savings of £4,000 per year to be made.
Extrapolating forward to when the individual is able to access the savings without penalty at 60, there would appear to be nothing to stop them from using the accumulated savings to make a large contribution to a pension scheme and claiming tax relief. Of course, the effectiveness of this would depend on income and other contributions at the time, but could potentially be a very efficient way of boosting retirement income.
Practical Tip :
On its own, the LISA is unlikely to challenge traditional pension plans; however, it could be worth using alongside a pension to boost savings, and to introduce some flexibility.
