Is this new Isa really better than a pension?

savings

The Government's latest savings product, the Lifetime Isa, is launching in April. But is it better than a pension? The"Lisa" - an Isa that works in much the same way as a pension - is one of the most controversial financial vehicles to be launched in decades.

Critics claim ordinary savers will be confused, stung by hidden exit penalties and likely to give up valuable employer pension contributions.

The Lisa is a long-term saving product, locking up cash until the saver buys their first home or takes the pot as a pension. Any contributions are boosted by a government bonus, but unlike a pension, it is not eligible for employer contributions.

For first-time buyers, the Lisa is far better than the Help to Buy Isa, which is being phased out by 2019 and has been beset by problems.

For the self-employed, who do not get workplace pensions, there is obvious appeal. But with the standard cash or stocks-and-shares Isa allowance rising to £20,000 as the Lisa launches, is it worth other groups investing significant sums?

How the Lifetime Isa works

To be eligible you must be over 18 and under 40 - anyone born before 7 April 1977 is excluded. Contributions receive a 25pc government bonus on any sum up to £4,000 a year - making a total maximum annual investment of £5,000. This continues until 50.

After this age no further contributions can be made, and the Lisa pot will only grow because of investment returns. As with all Isas, contributions are made out of post-tax income but returns and withdrawals are tax-free.

Withdrawals are penalty-free to buy a first property, at age 60, or because of terminal illness. Anyone wanting their money early for any other reason will pay a 25pc penalty. This may look like the Treasury simply taking back the bonus it paid but that is not the case.

The 25pc penalty comes off the entire value of your savings, including your contribution and any investment growth. It's a 6.25pc cut in your original investment - the only time the exit penalty does not apply is 2016/17, due to an administrative quirk.

Savers can make contributions into either a cash or stocks-and-shares Lisa. The choice depends on how much risk you want to take and what your goal is.

If you are funding retirement, a strategy focused on investing in stock markets is probably most appropriate. But for a short-term boost to your house deposit, a safer cash account might be better.

Anyone under 40 should open a Lisa. You only need to put £1 away to secure the option of investing for the following decade. Once you have passed your 40th birthday you lose the chance to open an account.

Given it will be 2037 before the first Lisa savers draw a retirement income, it is likely a future government will change the rules. Experts predict the penalty-free withdrawal options will be expanded beyond property purchase and terminal illness.

Adrian Boulding, of Tisa, which promotes tax-efficient saving, said"life events" such as moving to a bigger house or getting married may also be included in the future.

So make sure you give yourself the chance to use any future benefits. If the exit penalty worries you it shouldn't, at least not in the first year.

We looked at four case studies and assessed if the savers' cash should be in a Lisa, or if it could be put to work better elsewhere.

Scenario 1: The first-time buyer

Anyone yet to buy a property should open a Lisa on 6 April. Telegraph Money's Lisa calculator (available online) projects that an 18-year-old saving £100 a month into a stocks-and-shares Lisa using a cheap stock market"tracker" fund would have £40,000 by the age of 35.

Until now the Help to Buy Isa, launched in December 2015, has been the go-to scheme for those saving for a deposit. Yet its fundamental flaws, exposed by this newspaper in 2016, dented its reputation.

Unlike the Lisa - where the bonus is paid monthly - Help to Buy Isas get their top-up at the point of buying a property. But problems emerged around when exactly in the sale process savers received their money.

Guidance was unclear, with some solicitors and lenders assuming it was at exchange of contracts, while others said it was on completion. Also, Help to Buy bonuses are capped at £3,000 in total, while a Lisa bonus is only capped when the saver is 50.

Note that for 2016/17 only, the Lisa bonus will be paid at the end of the year. This means savers wanting to use their Lisa money for a property before the end of the 2016/17 tax year will run into the same problems that befell Help to Buy Isa customers: their top-up will not arrive in time.

Scenario 2: The basic-rate taxpayer

The Lisa's main rival is a pension. Both give a boost to money, either in the form of a bonus or tax relief, in return for locking money away for a long time.

At first glance it appears that for a basic-rate, 20pc, taxpayer, the Lisa's 25pc bonus offers more money. In fact, the bonus is exactly the same.

A basic-rate taxpayer only has to pay £4,000 to make a £5,000 pension contribution (the total is higher with"salary sacrifice") while £4,000 put in a Lisa also becomes £5,000.

Lisa withdrawals are tax-free, while pensions are taxed as income. But you can cash in a pension at 55, five years earlier than a Lisa.

Scenario 3: Higher-rate taxpayer, aged 20

Here there is a clear tax advantage for pensions. A higher-rate taxpayer only needs to pay £3,000 to put £5,000 into a pension, thanks to tax relief.

If the same person is a basic-rate payer in retirement, the pension is more tax-efficient, as they can make withdrawals and only be charged 20pc tax, despite the Lisa's tax-free withdrawal. Both basic and higher-rate case studies ignore the other advantage of a pension: employer payments.

From 2018 all employers will have to add at least 1pc of an employee's salary to a pension, a perk that is not available with the Lisa.

Scenario 4: 38-year-old higher-rate taxpayer

By 38 you should have built up a far more substantial pension. If you have a"defined-benefit" pension, which promises a guaranteed income, you may be near breaching the annual or lifetime allowance.

These restrict pension savings to £40,000 a year, or £1m in total. The older you get, the more likely you'll break a limit. So a Lisa is an excellent alternative option.

 

This article was written by Sam Brodbeck from The Daily Telegraph and was legally licensed through the NewsCred publisher network.