Chancellor of the Exchequer George Osbourne certainly hasn’t been afraid to try new things. They’ve all hit the headlines, but not always been successful. His latest attempt to get younger people to start saving is the recently announced Lifetime ISA, which will launch in April 2017.
Only open to those under 40, the Government has promised to add 25% on top of contributions (to a maximum of £1,000) per year, until age 50 – all of which can be withdrawn tax free at 60.
The Lifetime ISA scheme has been designed not only for committed savers but also for those younger investors who are looking to buy their first home. While there are stern penalties for withdrawing money from the account before 60 (which we will cover later), if the funds are used for a first house purchase then savers can withdraw money from the Lifetime ISA at any time without facing any charges.
Free money and access to thousands of investment choices – what’s not to like? The problem is, as some commentators have pointed out, that younger savers investing for retirement could become confused and turn away from pensions lured by the attractive offer of ‘free’ money from the Government.
The reason is that people may not understand the differences between investing in a Lifetime ISA and a pension. Eric Odell, head of the savings branch at the treasury may claim that ‘they aren’t a replacement for pensions’, but there’s still some confusion out there.
In this blog, we take a look at the differences between the Lifetime ISA and pensions. It’s a potentially complicated area but we’ll help you understand the difference.
The lifetime ISA is only open to those under 40, whereas a SIPP (self-invested personal pension) can be opened at any stage of your life. The Lifetime ISA is only available to those over 18, whereas it is possible to start a junior SIPP for under 18s.
You can have both a Lifetime ISA and a SIPP if you choose to.
As a pure saver, the Lifetime ISA gives you access to your money at 60. As already pointed out though, if you’re saving up to purchase your first home (or chose to do so at any point), you can withdraw the money at any time without any punitive charges, provided the house is worth up to £450,000 and is in the UK.
Accounts are limited to one per person rather than one per home – so two first time buyers can both receive a bonus when buying together.
With a pension you can access your money at 55 (57 from 2028). The difference with a Lifetime ISA is that withdrawals are untaxed. In a pension, the Government currently only lets you withdraw 25% of the total amount tax free, with the remaining amount subject to income tax. The amount of tax you pay depends on the amount of taxable income you and your partner receive each year.
If you’re investing for retirement, pension investments are locked away and protected until you’re 55, so there’s no way to access them. The Lifetime ISA however, will allow you to get access to your cash, but it comes with some strict conditions.
If you’re not buying a home and want to withdraw from your pot, you’ll lose out on all bonuses accrued on the amount, interest or proceeds from the growth and a nasty 5% penalty on the amount withdrawn.
Contributions to the Lifetime ISA are capped at just £4,000 per year (around £333 per month). Those with a pension can contribute up to £40,000 per year, with a lifetime limit of £1 million, provided they have UK relevant earnings to support this or £3,600 (gross) a year without UK relevant earnings.
Both investment options allow flexible contributions. To qualify for the maximum Government contribution, you will need to invest a total of £4,000 per year to the ISA. How you do this, is up to you – you can drip feed or invest in a lump sum.
It’s likely that Lifetime ISAs – like pensions – will be offered by all of the main investment providers, and will offer you access to a comprehensive range of funds, shares and investment options. Where you choose to invest is up to you. (We will come back to this a little later).
Tax free cash
The lure of tax free cash is one of the main selling points of the Lifetime ISA. If you’re under 40 and saving for a house, then this is one savings account you won’t want to miss.
For those saving for retirement, this so-called free cash is also one of the main points of contention.
Savers into the Lifetime ISA will benefit from 25% on top of their contributions for the tax year. However this amount is not paid into the savings account until the end of the tax year meaning the bonus does not attract growth for first 12 months (assuming you pay at the start of the tax year). Whilst you have to open your Lifetime ISA account before you are 40, you can keep on contributing until you are 50 once opened. As a result, the maximum amount of tax-free cash available is £32,000 (25% of £4,000 = £1,000 x (50-18) = 32 years).
By contrast, savers who make pensions contributions up to the Annual Allowance (currently £40,000 a year) from previously taxed earnings will automatically find that at least 20% tax is automatically added to their contribution. Higher rate and additional-rate taxpayers can expect to receive up to 40% and 45% tax relief respectively – substantially more than that offered by the Lifetime ISA.
One of the main concerns is that savers may not do the sums, preferring the lure of the Lifetime ISA’s cash return to the potentially more lucrative tax relief offered through pensions.
Is it worth it?
Crunching the numbers is a complicated business, and depends on your individual circumstances.
If you’re saving for a home, then the Lifetime ISA is a great investment. If you’re a basic rate taxpayer under 40, on paper the Lifetime ISA is a better choice of investment for you. You benefit from both more tax relief and greater flexibility – what’s not to like?
It should be clear that for higher rate taxpayers, the situation is slightly more complicated. It’s worth considering how your financial position is likely to change over time. As we get older, we’re likely to earn more as we ascend the career ladder, so your investment choices become more complicated. As a result, it’s worth getting some advice to help you make the best choices.
The Government’s aim for the Lifetime ISA is to get people saving, and it’s certainly likely to do that. It’s also pretty obvious that money that’s well invested will grow whether that’s in an ISA or a pension. The problem is, when faced with the staggering array of choices, we often don’t make the best ones for our money.
Whether it’s a Lifetime ISA, a pension, or both, the point of investing in either is to secure your future – potentially the most important investment you can make, so do it wisely.
We’re here to help you balance risk and reward, identifying the best investment options for long-term sustainable gain. Contact us on 0333 241 9900 to find out more.