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Explaining the Lifetime ISA

If you’re aged under 40 and thinking about saving for retirement, you might be considering the new Lifetime ISA. But how does it compare to what else is out there? Gill Wadsworth investigates 

Chancellor George Osborne has nailed his colours firmly to the ISA mast. Since 2010 Osborne has dramatically increased the amount individuals can save into ISAs, with his most recent March Budget increasing the annual limit from £15,240 to £20,000 from April 2017. 

Not content with boosting the attractions of traditional cash, stocks and shares, and the new Innovative Finance ISAs, Osborne also used this year’s Budget to introduce the Lifetime ISA – a new long-term saving vehicle for the under 40s.

Meet LISA, the Lifetime ISA 

You can use a Lifetime ISA to save for a first house or for retirement The LISA – as the new savings vehicle inevitably has become known – is designed to help young people get a foot on the first rung of the property ladder, or get people saving for retirement who might otherwise be turned off by traditional pensions.

At first glance, the LISA seems to offer an attractive range of features – a 25% top-up from government on contributions up to £4,000 and no tax on withdrawals if they are taken after age 60 or used to purchase a first home.

But inevitably, there are some strings attached. For a start, the exact details are yet to be worked out – Lifetime ISAs are still subject to consulation with e savings industry and then legislation.

To open a LISA, you have to be aged between 18 and 39 as of 1 April 2017, when they’re expected to launch. The government will only pay in the 25% top-up until your 50th birthday. 

If you use the money for anything other than buying a first home or access it before you turn 60, you lose both the government top-up and will be hit with a 5% exit penalty (there is an exception for people who may be terminally ill). LISAs also cannot accept employer contributions.

A flexible option 

Middle and high earners are most likely to feel that Lifetime ISAs will make it easier to save for retirement, according to new research from Skipton Building Society.  

The survey of over 3,000 British adults found that about half (46%) of those with household earnings of £35,000 or more thought Lifetime ISAs would make it easier for under-40s to save for retirement. 

Among those able to take advantage of Lifetime ISAs, half (49%) of those earning over £35,000 said they were likely to consider using them, compared to around a third (35%) of those with a household income of less than £35,000.

Among those aged under 40 who said they were unlikely to consider a Lifetime ISA, nearly a third (30%) said that it was unattractive to them, while 15% said they already use other savings products.

“There have been numerous significant changes to the pensions system in recent years with the introduction of new products, programmes and freedoms. It’s important to stop and listen to the impact that these changes are having on the way people view retirement,” says Jacqui Bateson, retirement specialist at Skipton Building Society. 

Don’t ignore pensions 

While Osborne’s efforts to boost long-term saving have been broadly welcomed, there’s a fear among some pension experts that the new LISA could prove to be a distraction from other, possibly more suitable, ways to save for retirement.

Younger generations are faced with more complex choices and need support around the decisions they have to make

Duncan Buchanan, president of the Society of Pension Professionals, says: “For many young people the allure of a LISA will be more attractive than saving into a traditional auto-enrolment workplace pension.

"But the longer term benefits of saving into a traditional pension to which an employer contributes should not be discounted altogether in favour of a LISA.”

In particular, the fact that you can’t pay employer contributions into a LISA is a disadvantage compared to traditional pensions. Employers are obliged to pay into a workplace pension scheme – and many employers will match what you pay in, doubling your money straight away. 

Even under the bare minimum demanded by law under auto-enrolment, an £800 employee contribution would receive £200 in tax relief, plus £600 of employer contribution – making £1,600. Ignoring investment growth, if you paid income tax at 20% in retirement, this £1,600 pension pot would produce a net return of £1,360, which you could access from age 55 under the pension freedoms. 

In comparison, paying £800 into a LISA would get a top-up of £200. If you needed to access your savings before age 60, not only would you lose the top-up, you’d only have £750 thanks to the exit penalty. 

Lisa Caplan, financial adviser at provider Nutmeg, says: “Pensions are a great way of providing tax relief on savings that can be used for income in retirement. This is particularly true when you expect to pay tax at a lower rate in retirement.

"A pension is still more favourable over a LISA if you're saving for retirement as money is locked away until age 55 and you get 25% lump sum tax free, but you are still taxed on the rest as income." 

Which might be the best option? 

With so many options to consider – each with its own set of rules, limits, advantages and drawbacks – long-term savers face a difficult decision.

Trying to balance flexibility with ensuring a reliable income in retirement is no mean feat, and when paying off debts and saving for a house are thrown into the mix, making the right choice becomes daunting.

Patrick Bloomfield, partner at consultant Hymans Robertson, says advice must be sought if people are to avoid making ill-advised choices. 

“Younger generations are now faced with more complex choices and they will need more support around the decisions they have to make, as there is definitely scope for poor choices to be made,” he says. 

Duncan from the Society of Pension Professionals says ultimately the right course of action “will boil down to an individual’s personal circumstances” and that “people will need advice on the most appropriate savings structure for them”.

The LISA has a lot of competition in the established ISA and pension options. But the idea of having a semi-flexible retirement saving option alongside the more rigid workplace pension and the completely flexible ISA seems sensible. 

This article has been commissioned by retiresavvy and any opinions voiced are the author's own.

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