The Rules of  the Lifetime ISA as it stands :-

Much has been theorised about the Lifetime ISA since it was announced. The questions is, will LISA be beneficial or not to savers?

Following the initial announcement of LISA  an updated technical note was published on 15 September 2016. This followed detailed discussions with the industry and confirmed the design.

The LISA has been introduced to Parliament on 6 September 2016 through the Savings (Government Contributions) Bill. This confirmed some of the already ‘known knowns’ including the limit on LISA which will be £4,000 of individual contributions per tax year.

This £4,000 limit will remain within the overall ISA allowance of £20,000 from the 2017/18 tax year. The £20,000 limit will be also cover stocks  and shares, cash and Innovative Finance ISAs.

The government will add a bonus of 25% to these contributions each year. The key change in the update is that this will now be added monthly from 2018/19 rather than at the end of the tax year, so the bonus can be invested straight away. This could have led to a significant investment lag if comparing this to a relief at source (RAS) pension contribution. However, this lag will exist for the 2017/18 tax year when the bonus will be applied after the end of the tax year. It’s also important to note that the 25% bonus mentioned earlier effectively mirrors the basic rate relief given to a RAS contribution, even though that’s referred to as 20% relief.

LISA will be available to ‘help young people save flexibly for the long-term throughout their lives’. From April 2017 adults under the age of 40 can open a LISA. Contributions can continue up to the age of 50.

The Rules of the Lifetime ISA as it stands

Money can be withdrawn from the LISA penalty free at any time (after 12 months from starting saving into the account) to purchase a first home worth up to £450,000. This appears to be a more helpful process than the current help to buy ISA process as the funds will be available, including the bonus, prior to completion of the purchase. This money is paid to the conveyancer, and if the purchase falls through or doesn’t complete within three months the money must be returned to the LISA manager by the conveyancer.

Those who are terminally ill with a life expectancy of less than 12 months will be able to withdraw the funds including the government bonus penalty free. This process will mirror the serious ill health lump sum rules with a pension, i.e. a medical practitioner will need to provide evidence of the life expectancy.

Thereafter, the only other time money can be withdrawn penalty free is after the age of 60.

Fees and charges for managing a LISA can be paid to the LISA manager without being deemed a non-permitted withdrawal.

Penalties

One of the key messages that has come out of the LISA is the penalty for accessing this early. Whilst this is a flexibility that pensions would not have, a key factor in early access is the 25% government charge that will be applied. When this is analysed this may be viewed as punitive. A 20% deduction is applied to ‘take back’ the government bonus. This would put a client back to parity (£5,000 taken from a LISA less 20% would in effect give the client their £4,000 back). But on top of this there is what is described as a ‘small additional charge’ applied, this works out as an additional 5%. So in effect if a client is known to need the money out with the LISA parameters, would an ISA not be more suitable if access is needed? Surely 100% of your money back is better than 95%?

As an aside, since pensions freedoms there has been much political talk about capping exit charges from pension if benefits are taken or transferred before the selected retirement age. Would a pension with a 5% charge be able to call this a small additional charge in the current environment?

It is worth noting that for some assessments of value the 25% charge to access funds will need to be taken into account, these include;

  • Welfare and social care means tests
  • Divorce
  • Bankruptcy*
  • Direct recovery of debt

* It is important to note this as the situation for pensions is different to this.  If a pension contribution was made in the last 5 years, the trustee in bankruptcy can challenge the transfer under the prior transactions provisions. However, if a transfer was made more than 2 years ago when the individual was solvent the challenge is likely to be unsuccessful unless it is proven the individual became insolvent as a result of the contributions, or if this was established as an avoidance measure.

The Rules of the Lifetime ISA as it stands :-

Much of the other rules for LISA will broadly be the same as with ISAs:

  • you can only contribute to  one LISA per tax year
  • they will be available to UK residents, and Crown employees and the spouses/civil partners
  • Opening a LISA should be similar to any other ISA (there may need to be more information provided and further declarations though)
  • As with stocks and shares ISAs it will be permissible to transfer shares from certain tax-advantaged employee share schemes*
  • Any investment which is currently eligible for stocks and shares or cash ISAs can be held in a LISA
  • Only an individuals own money may be contributed to a LISA
  • Withdrawing from a LISA will not increase the amount that can be paid during a tax year.
  • Transfers between LISA providers will be allowed and there will be no limit on the amount that can be transferred
  • Additional permitted subscriptions for a spouse or civil partner will be allowed on death (including the government bonus in the LISA), BUT the money will no longer be in a LISA and should the surviving spouse/civil partner choose to do so (and is eligible) they can pay up to £4,00 per annum into their own LISA.

* One potential handy planning angle is that it will be allowable to transfer an ISA of a different type into a LISA. The value transferred will count towards the £4,000 LISA limit, but this may be of use to those with ISA funds that they have built up with limited potential to fund the LISA another way as you will get the £1,000 government bonus by doing this. Whilst this will count for the LISA subscription for the year, it will not be taken into account for the year’s overall ISA allowance, so for 2017/18 there would still be a £20,000 ISA allowance available.

It should be noted that any transfer to a LISA from a Help to Buy ISA made after 6 April 2017 will not count against the contribution limit for the year in which they are transferred.

Additionally should a LISA be transferred to an ISA (or any other account or financial institution that is not an ISA manager) this  could be treated as a chargeable withdrawal.

A brief comparison

So looking at the information on LISA and comparing this to pensions, this is a short summary on the position of both below:

Pension LISA
Minimum age at entry 0 18
Maximum age at entry Unlimited 40
Age at which tax relief/bonus stops* 75 50
Normal annual limit Including tax relief/bonus £40,000 £5,000
Potential for additional tax relief or tax reductions? Yes No
Usually IHT free Yes No
Age at which benefits can be taken (excluding first house purchase for LISA)** 57 60
Penalty for early access (where allowed) Provider terms/scheme rules 25%
Potential lifetime contributions*** £2,280,000 £160,000

* Tax relief would not be available on contributions over age 75, but subject to scheme rules personal contributions can still be made beyond this age.
** Assumes that anyone that could open a LISA is max age 40, by 2028 minimum pension age will be 57.
*** Assumes for pension that contributions are the current Annual Allowance of £40,000 and contributions start at 18 to end at age 75. Tax relief at source is included). For LISA this assumes payments 18-50 and included government bonus.

Taking this into account is all well and good, there are pros and cons to use of either method. For instance you cannot withdraw money from a pension earlier than minimum pension age (barring protected ages and ill health) to purchase a house.  There has also been talk about potentially allowing a method of borrowing similar to the American 401k schemes, but so far nothing on this is in the design note.

On top of this there is a lot of press commentary from previous pensions ministers as well as the incumbent on the potential complexity that LISA may add and the overall value/detriment to saving for retirement.

Looking through all of this is comes down to one simple factor for financial planning, which wrapper (or a combination thereof) will make individuals richer. The only true way to analyse this is in the section below.

So let’s crunch the numbers

For LISA this a simple equation. If we ignore growth, and assume that no penalties are applied on access then given the bonus payments you put £100 in you will get £125 out, so you get back 125% of the payment. There is no additional tax relief, so this applies right through the tax bands from non-taxpayers to additional rate taxpayers.

For the pension comparison the mathematics is not as simple. But we will assume that contributions are made to a RAS scheme to match the LISA values (i.e. a payment of £4,000 is made to a pension provider).

Pension – £5k gross contribution

Total withdrawn at differing tax rates

Nil Rate Basic Rate Higher Rate Additional Rate
£5,000 £4,250 £3,500 £3,313

But based on the above table it would appear that the only way to match the benefits that an individual will get in their hand from a LISA to a pension is if they can fully extract the pension money within the personal allowance. Irrespective of the tax rate on withdrawal LISA will provide £5,000 based on the above assumptions. But this is not quite the case as the net cost of the contribution has to be factored in.

Pension – £5k gross contribution

Total out at differing tax rates

Tax rate on payment Net Cost* Nil
Rate
Basic Rate Higher Rate Additional Rate
Nil Rate

£4,000

125%

106%

88%

83%

Basic Rate

£4,000

125%

106%

88%

83%

Higher Rate

£3,000

167%

142%

117%

110%

Additional Rate

£2,750

182%

155%

127%

120%

* The net cost shown factors in any additional tax relief that can be reclaimed for higher and additional rate taxpayers, and that the whole contribution falls within that tax band. So for the additional rate taxpayer they have to make a payment of £4,000 to the RAS scheme but in their tax return they can reclaim an additional £1,250 of tax paid, which gives the net cost above. There will be a time lag on this to provide balance.

So when the analysis is done on the percentage return it shows different picture. If you are going to move up a tax bracket or stay in the same one when retiring (barring the non-taxpayers) then LISA looks like the obvious choice.

For a non-taxpayer who is making contributions, LISA will make no difference to a pension if they remain non- taxpayers in retirement. This is also the case for a basic rate taxpayer, if they are a non-taxpayer in retirement.

But pensions will win for higher and additional rate taxpayers if they drop a tax band in retirement, something that may be likely and research from the Centre for Policy Studies research has estimated that 6 out of 7 higher rate taxpayers are not higher rate taxpayers in retirement. So on this basis would an individual prefer a 142% return on their money or a 125% return? Conventional wisdom would go for the former.

But it all boils down to the staples of planning for individuals, what do they have, what do they need and when do they need it? LISA is just another wrapper that needs to be considered within the range of wrappers available. For instance the returns are more favourable for a basic rate taxpayer now and in retirement from a LISA if they need the money after they are 60, but if the money is needed between 57-60 then LISA may not be suitable given the potential penalties.

Source: Prudential

Wanting advice and help with ISAs and LISAs? As one of the leading IFA practices in Greater Manchester, Logic Wealth Planning has a team of experienced Financial Advisors specialising in Wealth Management. Working closely with clients in the Heywood, Rochdale, Bury and surrounding areas across the North West, we believe that however modest your income may be, when it comes to Pensions, Savings and Investments  we provide the best financial advice, ensuring that your money is working hard for you and allowing you to enjoy a comfortable lifestyle right through to and including your Retirement years. For your first meeting with us – entirely free and without obligation – please call us now on 0808 1234 321. We look forward to hearing from you.