In his Budget on Wednesday, George Osborne announced the introduction of a new ISA product designed to stop younger people from having to make the difficult decision between saving to buy a home and saving to make sure that they have enough money to live off once they retire.
Prior to the Budget announcement, various potential reforms to the pensions system were discussed before being ultimately discounted. Among these was the idea to reshape the way in which tax relief is granted on pensions, creating an effective ‘Pensions ISA’.
Currently, pension contributions are tax-free, and then tax is paid on withdrawal (with a certain amount of tax relief there as well). The Pension ISA system would see this reversed; tax would be paid on contributions, but none on withdrawal.
These plans were scrapped, but the Lifetime ISA certainly pays homage to the same idea, with a sprinkling of Help to Buy thrown in for good measure.
In announcing it, Osborne cited the confusion that many (especially younger people) face when trying to get to grips with the pensions system. This claim has pretty solid grounding: a recent study from the FCA found that as many as 50% of consumers did not fully understand pensions and the Pensions Policy Institute described the decision over when and how to withdraw pension funds as “among the most complex” financial decisions that any of us will make.
Part of the confusion, or at least difficulty, comes from the fact that with house prices as high as they are right now, many under 40s are faced with the tricky decision of having to choose between saving for a house and saving for a pension.
The Lifetime ISA aims to tackle all of the above issues by offering a streamlined way of saving, with very reasonable returns, and allowing savers to work towards both a house and a post-retirement income.
So how exactly does it work?
The government’s ‘Lifetime ISA factsheet’ explains the functionality pretty succinctly:
“Save up to £4,000 each year, and receive a government bonus of 25% – that’s a bonus of up to £1,000 a year. You can use some or all of the money to buy your first home, or keep it until you’re 60 – it’s up to you.”
Let’s unpack that:
Anyone between the ages of 18 and 40 can open up a Lifetime ISA, and the 25% government bonus will be given each year up until you turn 50.
There is no monthly deposit limit; you can put the whole £4,000 in in one go if you so desire.
You’ll also earn interest on top of the government bonus. So, if you deposit the maximum each year, and you could be getting £1,000 from the government, plus, say 4% interest (on the total amount)
Shades of Help to Buy
Then, you can use your savings, bonus included, to put towards a deposit on a house with up to £450,000, so long as it’s your first home – here’s where the Help to Buy aspect comes in. In fact, if you already have a Help to Buy ISA, you can, from 2017, transfer the balance into a Lifetime ISA.
You’re welcome to keep the two separate, but you can only use one to contribute towards a deposit on a house. Use your Help to Buy ISA for a home, and you’re locked into using the Lifetime ISA as a source of post-retirement income.
As with the Help to Buy scheme, you can buy a house with a friend or partner, combining both of your ISAs and doubling your spending power, though the price limit on the house you can buy will not double.
If you choose not to use your Lifetime ISA to buy a home, or indeed if you only use part of it to do so, then the what remains is there for you once you start to reach retirement age.
When you turn 60, you can start to take out the money from your Lifetime ISA, tax-free, bonus and all. You can do with this money whatever you wish – use it to live off, go on holiday, by an exotic pet, you get the idea.
You can withdraw your funds at any point before you turn 60, but if you do so you’ll sacrifice your government bonus (as well as any interest earned on it) and you’ll have to pay a 5% fee. As you can imagine, this is not a recommended course of action.
So a Lifetime ISA is like a cross between a Help to Buy ISA and a simplified pension plan, or a 10-32 year fixed term savings account with a very high interest rate.
As Deloitte’s Nigel Barker explained: “Philosophically it does seem to be a Pensions ISA, with a nod towards first-time buyers”. Adding that “you’re not as locked in as a pension fund; it feels more flexible.”
Independent from Pensions and ISAs
Despite these “philosophical” similarities, the Treasury has been sure to maintain that the Lifetime ISA is not a pension product; that it is not a replacement for a conventional workplace
or state pension. You can have a conventional pension and a Lifetime ISA at the same time, enjoying tax benefits from both without either interfering with the other.
Nor will it clash with a conventional ISA.
Osborne also announced a rather dramatic increase to the annual ISA allowance, from just over £15,000 to £20,000. So you could, theoretically, store £20,000 in your cash or stocks and shares ISA each year, and a further £4,000 in a Lifetime ISA. If you have a spare £24,000 each year that is.