Make no mistake about it – George Osborne’s Lifetime Isa is more than just a neat little wheeze designed to woo low-earners to vote Tory in 2020. It is a clear signal to the pensions industry that the current tax relief system is on its way out.
The Chancellor was blocked from pursuing the radical reform he obviously craves only by concerns over the impact it might have on voters ahead of the EU referendum on 23 June.
But the announcement of a stripped-back version of the pension Isa – and the failure to rule out wider reform in the future – means the direction of travel is now clear. The pensions industry has a stay of execution, but nothing more.
What that reform will look like is not yet entirely clear, however. There are two options on the table: flipping tax relief on its head so contributions, rather than withdrawals, are taxed; or moving to a flat rate.
If Osborne opts for the former, pensions as we know them today will become extinct.
And if he plumps for the latter, the industry will be hoping the Lifetime Isa incentive is not a window to the future. Under the scheme, savers will be able to save up to £4,000 a year and receive a 25 per cent “Government bonus” worth up to £1,000.
That equates to tax relief of just 20 per cent – a good deal in the context of a product where withdrawals are tax-free, but a huge tax grab if transposed into a flat rate system where withdrawals are taxed at the saver’s marginal rate.
According to analysis from the Centre for Policy Studies, limiting tax relief this way would save the Treasury £7bn a year. It would also massively reduce the incentive to save for higher earners.
The speed at which Osborne will pursue fundamental reform is anyone’s guess at this stage. The Autumn Statement will be the next Treasury set-piece, although the Chancellor may now want to gauge the popularity of the Lifetime Isa before pushing forward with an overhaul of the pension tax relief system. That would potentially see big changes revisited in 2018 – a politically sensitive time given the proximity to the general election and Osborne’s long-harboured leadership ambitions.
Would he really want to pick a fight with The Telegraph and The Mail at this stage? Is the pension Isa or a low-level flat-rate – and the money it would raise – worth the risk?
It’s possible such concerns will temporarily kick the can down the road – potentially even beyond the general election – but barring a Labour victory in 2020, reform looks inevitable.
In the meantime, the door remains open to further tinkering to boost Treasury coffers – trimming the annual and lifetime allowances, for example, or further restricting the annual allowance taper due to come into force next month.
Far reaching implications
In the short-term, the Lifetime Isa could also have ramifications for trust-based pension schemes, particularly those serving low-earners. Analysis from Hymans Robertson (see table below) suggests it represents a very good deal for basic-rate taxpayers.
The pensions industry has already begun to howl with discontent that the attractiveness of the Lifetime Isa risks undermining the flagship auto-enrolment programme.
Aegon pensions director Steven Cameron says: “There is a huge risk that the Lifetime Isa will encourage some under-40s to turn down the opportunity to be auto-enrolled into a workplace pension, even though that comes not only with the equivalent 25 per cent Government bonus on personal contributions, but also with an extremely valuable employer contribution.”
While the forces of inertia that have propelled the successful roll out of the reforms to date are strong, for many people this will be an ‘either/or’ scenario and opt-out rates will inevitably be pushed up as a result.
For Nest, the scheme set up by Government to support the reforms, this also raises more awkward questions over its ability to repay its £387m DWP loan.
The Lifetime Isa – how it will work
- Save up to £4,000 a year and receive a Government top-up of 25 per cent, up to £1,000
- Available to anyone aged 18-40
- Savings put into the scheme before 50th birthday receive 25 per cent top-up
- Savings and Government top-up can be used towards deposit on first home worth up to £450,000, or withdraw tax-free after 60th birthday
- Money withdrawn before age 60 loses Government bonus (plus interest and growth on this), and is subject to a 5 per cent charge
Tom Selby is head of news at Money Marketing