Do Lifetime ISAs risk derailing Automatic Enrolment or can they remain targeted to help first time buyers build increasingly hefty deposits?
21 April 2016
Adrian Boulding - Retirement
Strategy Director at Dunstan Thomas
Since George Osborne announced the arrival of Lifetime
ISAs (or Lisas) in his spring Budget speech last month,
there has been a torrent of criticism from the adviser
Steve Bee summed up the mood in one article: “I’m very concerned about the destabilising effect an alternative pension system will have on the roll out of Automatic Enrolment.”
The Association of British Insurers (ABI) has also been quick to voice pension providers’ concerns. The industry body will host the Transforming Long Term Savings Conference next week and plan to use it to put the potential impact of Lisas on Auto Enrolment (AE) front and centre of the discussions there. Parliament’s Work and Pensions Committee are so concerned that the Lisa might derail AE’s success that it has re-opened the ‘Pensions automatic enrolment inquiry’, posing some key questions as follows:
1. To what extent is the Lifetime ISA compatible with AE and the Government’s wider pension strategy? What impact could the introduction of the Lisa have on opt-out rates?
2. To what extent will the Lisa fill the gap in retirement savings among the self-employed? Are there more appropriate alternatives?
3. Which groups would be better off saving into a Lisa than they would be under AE?
Industry luminaries, including the architect of the ‘make ISAs the key retirement savings vehicle’ thinking Michael Johnson, have been invited to give oral evidence in front of MPs this week.
So how will this new Lisa work, assuming it remains as it is through to 6th April 2017 when it goes live? Those aged between 18 and 40 can open a Lisa account and save up to £4,000 a year with a carrot of a 25 per cent bonus from the government on the savings put in before they reach their 50th birthday.
An individual who contributes the £4,000 maximum each year can therefore expect a bonus of £1,000 at the end of each tax year, which over the long-term, could yield a sizeable savings pot. As with current Isas, contributions are made out of post-tax income but investment growth on savings and future withdrawals are tax-free.
In terms of saving for retirement using a Lisa, the idea is to keep the fund until after 60 years of age as it can then be withdrawn tax-free. If the money is withdrawn before 60, then the government bonus is lost, together with any interest earned on the bonus element. To add insult to injury, there will also be a five per cent penalty taken from the saver’s own money. Clearly the plan would be to keep funds in for the long term and to have the account as a part of a retirement savings plan.
Whilst the new product adds a fresh dimension of choice to the market, - as part-long-term retirement savings vehicle and part-flexible savings product helping young people to build funds towards paying the deposit on their first house - it likely to create considerable confusion amongst customers as to which one is best for them.
Does it come from the same stable of Treasury offerings designed to help young people get on the housing ladder from which we have just seen the ‘Help to Buy ISA’ go live just four months ago? The terms of the Lisa are arguably more favourable because the 25% Government bonus doesn’t have to be spent on a first time house purchase. It can be saved for retirement, and the Chancellor has dangled the carrot that other opportunities to make withdrawals with the bonus intact will be added as lifetime concepts later. It could be argued that it is a good incentive for everyone aged over 18 and under 40 to ‘go for broke’ to secure their first home. A couple saving the maximum of £4,000 each into their Lisas could, with the bonus, expect to build the current average house deposit of £35,000 in under four years.
But it would be unlikely that a 38-year old male employee earning his average UK wage of £26,000 would be able to put aside much more than £300 per month to build his Lisa pot for a deposit. That means that he might not be able to afford to pay towards an AE pension while he is trying to get on the housing ladder via Lisa, especially as from April 2018 AE rules demand that he puts in a minimum of 3% of his qualifying earnings (while his employer puts in 2%) each month.
The stark reality of disposable income is that for the vast majority of savers, they’ll need to choose between pension and Lisa as they won’t be able to afford both.
If he is self-employed and is therefore not included in AE, or earns below the AE qualifying earnings threshold of £5,820 per year then clearly Lisa-based saving for purchase of a first home, or for retirement, makes good sense; especially as he can tap into these savings at any time as long as he is willing to lose the 25% bonus and be charged 5% penalty for withdrawing it before age 60.
A Lisa might also be taken out by a (very) small minority of higher earning employees under the age of 40 that think that the combined statutory contributions (rising to 8% of income in total from October 2018) into their AE pension is not enough to enable them to reach their retirement savings target. This group may have the luxury of being able to pay into both a workplace (AE) pension and a Lisa.
The other question is will the Lisa prove successful enough to offer a good mainstream workplace retirement savings alternative to the AE pension? Will we see providers coming through with workplace Lisas over the next year as AE opt-outs rocket? It is very difficult to know at this stage but it seems inevitable that banks and building societies, already emboldened by FAMR, will be keen to offer Lisas as a first time buyer saving solution which has the flexibility to morph into your key retirement savings pot, complete with facility to access your pot to fund (possibly) a myriad of life events.
The Lisa is likely to have strong appeal for the growing army of self-employed. Office of National Statistics (ONS) figures estimate that the self-employed now makes up 15% of the UK’s workforce. Numbers have risen by 1.1m since 2009 to reach as total of 4.6m self-employed by the end of 2014. ONS figures also suggest that more than half (53%) of all self-employed people are under 49. So this is a large group of people who need to be saving for retirement but which are locked out of the benefits of statutory employer contributions, and employer and employee NIC relief which comes with AE pensions. And the Lisa’s 25% annual bonus comes close to matching all those tax relief benefits.
Having considered the whys and wherefores of Lisas versus AE pensions, it is also clear that never was there a more relevant starting point for financial advice. Lisas offer a solution for saving up for a deposit to get on the housing ladder but also a route to retirement saving. Should the Lisa saving do its job, the next thing an adviser can be talking to a new customer about is mortgages and associated life assurance options. Then discussions about saving for other life events, including retirement, can begin.
For new breed adviser firms looking to build young, aspirational client-base, many that they might advise for the rest of their working lives, surely the ‘Lisa versus standard AE pension’ discussion is a good place to start any financial planning discussion?
Adrian Boulding is Retirement Strategy Director at Dunstan Thomas