DIY INVESTOR TOOLKIT: Is the Lifetime Isa a good choice for you?

Is the Lifetime Isa a good choice for you?

Another tax year, another Isa. Since the 2016 Spring Budget, savers and investors have had a new product to add to the growing list of different Isas that are now available: the Lifetime Isa (Lisa). Here is a summary of how it works, and some factors to weigh up before opening one.

To be eligible for a Lisa you must be aged over 18 and under 40. The good news, for those who qualify, is that any money you pay into a Lisa can not only be put to work in a wide range of investments but also attracts a 25 per cent government bonus.

The maximum contribution from you is currently set at £4,000 a year, which makes a total annual investment of £5,000 with the maximum government top-up included. This will be paid annually for the first year and then monthly after that.

Contributions can then be made every year until you reach the age of 50, after which no further contributions can be made, so any subsequent growth will purely come from investment returns.

The maximum bonus you can build up under the current rules is £32,000, which would require a contribution of the maximum £4,000 every year from the age of 18 up to 50 (32 years).

A big catch

As with all Isas, withdrawals are tax-free. However, unlike a standard Isa, which allows withdrawals for any reason, they may not be made penalty-free from a Lisa unless it is for certain specific purposes:

• To buy a first property worth less than £450,000

• At the age of 60 for retirement• If you are suffering from a terminal illness (or die).

Anyone wanting their money early for any other reason will pay a penalty, other than for withdrawals in the first year 2017/18.

This penalty equates to:

• Any government bonuses received to date, plus

• Any interest or growth accrued on them, and

• A 5 per cent exit surcharge.

In effect, you are therefore being penalised to the tune of 25 per cent of the value of your fund. This means anyone opening a Lisa should be sure that they will apply any funds to buying a property or retirement.

So, should you have one as part of a lifetime savings strategy? The answer for many investors will not be as clear-cut as some commentators are making out, and will depend heavily on your personal circumstances.

The balancing act for retirement savers

The Lisa’s main rivals when it comes to lifetime savings towards retirement are a standard Isa and a personal pension. All three are investment wrappers that facilitate tax-effective saving, but they have some key differences, summarised in the table below.

Product Lifetime
ISA
Investment
ISA
Personal
pension
Minimum age 18 18
(adult ISA)
18 (adult SIPP)
Maximum age 40 to open,
50 to
contribute
None 75 (for tax relief)
Basic rate tax
relief on contributions @20%
No No Yes
Higher rate
tax relief on contributions
No No Yes
Tax-free
growth within the wrapper
Yes Yes Yes
Government
bonus on contributions @20%
Yes, capped
at £1,000
per year,
£32,000 total
No No
Tax-free
withdrawals
Yes Yes First 25% only
Penalty-free
withdrawals
Only as
specified
Anytime From 55 (57 from
2028)
Penalty rate 25% None 55% (if over lifetime
allowance)

The decision as to which one is better will therefore depend on personal circumstances. When considering which vehicle is best for lifetime saving, you should really make the assumption that your money is being invested for the long term before committing to stock market-based investments.

For many basic rate taxpayers a workplace pension is a great starting point for retirement saving. They offer tax relief at source, so that for every 80p you pay in, the government contributes a 20p top-up.

Furthermore:

• Employers can contribute to a personal pension (but not to a Lisa or Isa).

• Employees can make personal pension contributions tax-efficiently via salary sacrifice (but cannot do this through a Lisa or Isa)

• The minimum age to withdraw pension funds is currently 55 (rising to 57 in 2028) versus 60 for a Lisa and any age for a standard Isa.

Set against this, only 25 per cent of a personal pension fund can be withdrawn tax-free from age 55, with the rest taxed as income. Withdrawals are tax-free at age 60 from a Lisa and at any time from a standard Isa.

A tougher decision is whether a younger employee, who already has a pension through their employer, should contribute additional sums to that pension or open up a separate Lisa.

The advantage of the Lisa is a bit of extra flexibility, should the money be needed for a first property purchase later, and the fact that the government in effect matches the basic rate relief available from a pension with a Lisa bonus.

For many higher rate taxpayers the winner will be a personal pension, provided they are happy to lock their money up until at least age 55. That’s because of the higher-rate tax relief available on the way in – basic rate relief is given at source at 20 per cent, with a further 20 per cent reclaimable by the employee via a self-assessment form; this can also be invested into a personal pension. The biggest winners from the current pension system are those who can claim higher rate relief on the way in and anticipate being basic rate taxpayers in retirement.

However, given the lifetime allowance ceiling placed on the total value of a pension fund when it is crystallised (currently £1 million) and the tapering that is applied to contributions once adjusted earnings exceed £150,000, a Lisa could still be a useful supplementary savings vehicle for some savers.

For many higher earners this lifetime allowance limit means that whilst a pension will provide the best route to lifetime saving initially, anyone who predicts that they may breach the £1 million ceiling – perhaps successful young professionals in their 30s and 40s – may want to consider a Lisa to run alongside it. They won’t get higher rate relief on contributions, but they will get the government bonus and the Lisa will be excluded from the £1 million ceiling calculation.

For the self-employed who are saving towards retirement, a personal pension offers similar government support (basic rate tax relief at 20 per cent) to a Lisa (a 20 per cent bonus); for higher rate taxpayers, the additional tax relief available via a self-assessment form leaves a personal pension out in front. However, anyone facing the possibility that they may breach the lifetime allowance may wish to consider a Lisa for further contributions.

Standard Isa holders who are using the product to part-fund retirement may want to consider contributing to a Lisa instead, to get the 25 per cent bonus – on the understanding that they cannot access the money without incurring a penalty until they turn 60. Anyone who has built up money within standard Isas for retirement purposes could look at switching some of it into a Lisa in order to get the government bonus on contributions.

For older family members the Lisa could be a good way to make gifts to younger adult members of the family (aged 18 or older). Anyone can contribute to a Lisa provided the money is paid in by the account-holder. So a grandparent could make a gift to a grandchild, which is then paid into a Lisa to attract the 25 per cent bonus. Both parties will need to be aware that the money is then only available penalty-free for a subsequent property purchase, or retirement.

For Junior Isa holders who wish to carry on saving flexibly beyond the age of 18, perhaps with parental help, the Lisa could offer an attractive lifetime savings vehicle for up to £4,000 per year (to attract the maximum bonus of £1,000), with a standard Isa offering the maximum flexibility for any further amounts. Again, the restrictions on how the money can be subsequently used must be noted from the outset. For those who require full short-term flexibility on subsequent withdrawals a standard Isa may be the better bet.

Conclusion

Although the government no doubt hoped to simplify saving for many by introducing the Lisa, choosing the correct lifetime savings vehicle will remain a complex decision for many. For a further discussion of the best strategy for you, please contact a financial adviser.

Jonathan Drysch is an Associate Director at Killik & Co.

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