The new Lifetime ISA, or LISA, was introduced in April, as the latest member of the ISA family. It is proving so popular, industry research has shown that it is causing many to rethink their retirement saving plans.
It’s easy to see why. Like the other ISAs the LISA offers tax efficient saving. The money you put in will grow without the taxman helping himself, and when you come to take out your cash, you can do so without any Income Tax or Capital gains liabilities.
But the LISA offers something other ISAs can’t – a 25% bonus on everything you contribute, worth up to £1,000 a year.
Free money from the government is hard to beat. It’s one of the reasons that has ensured LISA saving has been eagerly adopted by the under-40s it is aimed at.
But does the LISA work for everyone?
LISA in brief
- Open to those aged 18-40
- Save up to £4000 per year
- Enjoy tax efficiency – the taxman cannot touch your LISA
- Government adds 25% to the cash you contribute
- Take tax-free cash out – but only:
- To buy a first home
- After you turn 60
Caution – your savings are locked away otherwise
What exactly is happening?
Those aged between 18 and 40 have important choices to make when they are thinking about how to save for the future. Pensions, ISAs, help-to-buy ISAs and regular savings accounts all provide ways to save. But some are likely to be much more rewarding than others.
The availability of the LISA has made the choice even harder. Many younger workers are now tempted by the LISA’s bonuses and tax efficiency. Another major draw is the opportunity to build up a lump sum that can eventually be withdrawn and used with complete freedom from tax – something that pension saving cannot.
According to research conducted by Hymans Robertsob, more than 60% of workers under 40 would open a LISA.
For basic rate tax payers, this could mean getting a bigger contribution from the government, with 25% bonus instead of 20% tax relief. This might be a real advantage to self-employed basic rate taxpayers.
However, some respondents even state that they plan to leave their workplace pension scheme to concentrate on saving into their LISA. This might be a rash decision. It means going without employer contributions, which are essentially free money from their employer. Upfront tax relief and employer matching contributions can be an even bigger contribution to future wealth than the money the government will put into a LISA.
Former pensions ministers Steve Webb and Ros Altmann have raised concerns that the LISA would tempt people to opt out of auto-enrolment, and lose out as a result.
For higher rate tax payers, the position is even clearer. The tax relief in a pension can be considerably more valuable than an LISA bonus. Plus, the £40,000 annual pension contribution limit is substantially more generous than the £4,000 annual LISA limit.
The best of both worlds
It looks as though the majority would be better off using a pension as their main retirement savings vehicle rather than a LISA.
However, there may be a case for having both. Over two thirds of those surveyed said that they would save into a LISA alongside a pension. Of those who would contribute to both, 49% would save more to a pension and 19% would save more to a LISA.
Contributing as much as possible to a pension and LISA in parallel might be a good way to enjoy the benefits of both savings methods. It could allow the saver to take advantage of the taxman’s generosity towards pension saving, while also building up a cash lump sum that he cannot touch.
It could include employer contributions to the pension, and the tax efficient growth potential of an ISA.
For some savers, LISAs might be a distraction from potentially more rewarding pension contributions. But for others, and particularly for high earners who have already reached annual or lifetime pension allowance limits a LISA could be an effective way to boost their overall retirement savings.
What should you do?
Whether a LISA or pension is a more rewarding savings vehicle will depend on a number of factors, including your employment status, your tax band, your age and your outlook.
If you choose both, you still have decisions to make. The proportion of your available funds that you direct to each one will also depend on your individual circumstances. The LISA is new, and there are many questions you should ask before committing yourself.
The value of investments can go down as well as up and you may not get back the amount invested.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.
Levels and basis of reliefs from taxation are subject to change