What’s all the fuss about LISA?Steven Cameron, Pensions Director 2 December 2016 Back to results
It’s no secret, the younger generation is headed down a challenging path when it comes to savings. If you are trying to buy your first home, or have considered your retirement savings, it’s not looking as rosy as you would hope.
Intended as a means of saving both for a first house deposit and for retirement, the Lifetime ISA has attracted the attention of the younger savings generation. While this is definitely a welcome step in the right direction, the LISA is not the answer to all of millennials’ saving prayers.
For young savers, the range of options currently on the market both for retirement and buying a home can be overwhelming – quite frankly, it’s a minefield. So, let’s break it down…
25% bonus each year? What’s not to love?
When you contribute into a LISA, you get 25% added to it by the government. From next April, you can save as little or as much as you want each month, up to a total of £4,000 each year.
If you are committed to using this money for a first house purchase (of up to £450,000) or leaving it until age 60, this is very valuable. Paying in the yearly maximum of £4,000 automatically means your savings total will shoot up to £5000 once the bonus is added.
Savers can contribute to the LISA and receive bonuses from the age of 18 right up to the age of 50, as long as the LISA is opened before they turn 40.
There’s no such thing as free money – is there?
- The exit charge and how it works
A major drawback of the LISA is flexibility. For those who might choose to access their savings before age 60, (for reasons other than the purchase of a first home), withdrawals incur a penalty of 25%.
On the surface, you might think that this means the 25% bonus you received is just taken back but, it’s a bit more complicated.
In practice, the 25% penalty is based on the amount after the bonus and investment growth have been added. This actually means that, if you decided to access all your cash (£5,000) after one year, (ignoring investment growth) you’d only get back £3,750. Effectively, you will have paid an additional penalty of £250 for accessing your money early.
Saving for a first home is hard, and although some might choose to invest their deposit pots in stocks and shares (that could go up or down with market changes), most are likely to choose to invest safely in a cash based fund.
In today’s low-interest rate environment, you’d be lucky to get more than 1% interest on a cash ISA, so the £250 additional penalty that you would lose in this example could easily wipe out 5 years of interest.
So what’s the difference between the LISA and the Help to Buy ISA?
For those saving for a first home, the LISA will in time replace the Help to Buy ISA (H2B) and allows higher contributions to be invested. Help to Buy ISA contributions are limited to £200 per month after an initial deposit of up to £1,200. The maximum bonus is £3,000 over your complete savings period.
However, as the H2B ISA receives its bonus only on at the point of first house purchase, there’s no penalty if you decide to accesses your savings for other reasons.
Those not affected by the H2B limit and who are happy in cash may prefer to keep paying into their existing plan to avoid the potential of an exit penalty within LISA. While H2B ISA funds can be transferred into LISA, and in the 2017 / 18 tax year this won’t count towards your LISA yearly maximum, this needs to be considered carefully remembering it immediately introduces the possibility of an exit charge if money is used for anything other than a house purchase,
How does the LISA stack up against personal and workplace pensions?
If you’re considering your retirement savings options, then it’s worth remembering that under the Government’s automatic enrolment policy, all employees earning above £10,000 a year are enrolled into a workplace pension. Employers are required to contribute a minimum amount and employee contributions also benefit from a Government top-up in the form of ‘tax relief’.
For a basic rate taxpayer, the Government top-up is equal to the 25% LISA bonus but the employer contribution can be much more generous. It’s not uncommon for the employer to ‘match’ the employee contribution after Government top-up. This could mean every £800 an employee pays into their pension from take-home pay could become £2,000 overnight. While some of the income taken from a pension is subject to income tax, workplace pensions can still represent much more value than LISA for retirement savings.
The self-employed don’t benefit from auto-enrolment and there is no ‘employer’ to add contributions. So for them, the LISA will offer an attractive alternative to current personal pensions. However, it’s important to remember that the Lifetime ISA is only open to those under 40. Self-employed individuals who are paying higher rate tax could find that pensions are still more tax efficient because of the more generous Government top-up, equivalent to 66%, higher rate taxpayers receive on pension contributions.
What about saving in general? Could the LISA be right for you?
For individuals committed to saving for a first home, the LISA with its Government bonus will be attractive, although those saving within the H2B ISA limits may hold onto these to avoid the chance of an exit penalty if they withdraw funds for other reasons.
Employees saving for retirement will almost always be better off using workplace pensions where they also benefit from employer contributions. Younger basic rate self-employed individuals may find LISA an attractive alternative to personal pensions.
It’s important to bear in mind that life often throws a few curveballs at us. It always makes sense to have some rainy day money that is immediately accessible, free of penalty charges, and neither pensions nor LISAs offer this.
Although the LISA might be right for some, it’s not the flexible solution to various saving needs some may make it out to be. For most people, it makes sense to have a range of different savings pots including pensions, ISAs, bank accounts and possibly a LISA. Thankfully, technology is making it easier to manage all these investments. ‘Platforms’ (as they are known in the pensions and investment world!), allow investors to go online to review and manage all of their savings in one place.