The introduction of the Lifetime Isa, as announced in the Budget, has received a reasonably warm welcome. A suspicion remains it is just a Trojan horse for a pension Isa and some still fear it may negatively impact on automatic enrolment. However, taken at face value, the combination of a savings vehicle targeted at younger savers and a significant increase in the wider Isa annual subscription limit has been viewed positively.
The Lifetime Isa will feature the traditional Isa benefits of an exemption from tax on capital gains and investment income. Savers will be allowed the choice of cash or stocks and shares Lifetime Isas, although access to peer-to-peer lending will not be available.
The key attraction of the Lifetime Isa for savers is undoubtedly that subscriptions paid between the ages of 18 and 40 will benefit from a 25 per cent bonus. This bonus will be retained if funds from the Isa are used to purchase a first home or if they are kept within the Isa until age 60. Only if the saver withdraws funds before they reach 60 for reasons other than a first home purchase will the bonus have to be returned, with a 5 per cent exit charge added on top for good measure.
And it is this 5 per cent exit charge that continues to attract more criticism than any other aspect of the Lifetime Isa.
A key point being considered is whether the charge falls foul of the European Union’s Mifid II rules, which are designed to prevent certain products using an exit charge that makes it illiquid. It has been argued a penalty as significant as 5 per cent of the value of the with-drawal would breach those rules.
A charge of 5 per cent also appears inconsistent with the wider regulatory focus on exit charges, particularly those discouraging savers from accessing the new flexi-access drawdown and UFPLS options. If the Government introduces a cap on pension exit charges that is well below the 5 per cent penalty applying to Lifetime Isas, it is likely to face calls of hypocrisy.
So why did the Treasury and HM Revenue & Customs include this 5 per cent exit charge when designing the product?
One suggestion is the haste with which it was designed may have caused issues. Rumours are the design of the Lifetime Isa took place in the weeks leading up to the Budget, rather than being part of a longer-standing vision. With the Treasury announcing plans to reform pensions tax relief were being shelved less than two weeks before the Budget, is this a possible candidate for the Lifetime Isa’s date of conception?
It is also possible the 5 per cent exit charge is intended to create parallels with the mechanics of the unauthorised payment tax charge that can apply to pensions. Except in very limited circumstances, withdrawals from a pension before the member reaches 55 are penalised by a 40 per cent tax charge on the scheme member, the possibility of a 15 per cent surcharge depending on the amount withdrawn and a tax charge of between 15 per cent and 40 per cent on the scheme administrator, which is often paid from the scheme member’s fund.
These unauthorised payment tax charges have been set at a level intended to both negate the tax reliefs that pensions attract and to discourage withdrawals before the minimum pension age set out in legislation.
With the 5 per cent Lifetime Isa exit charge only applying to withdrawals before age 60, there is a read-across with the age-based mechanics of the unauthorised payment charge on withdrawals from a pension.
The question is, if the exit charge is designed to correlate with pensions rules, is it right that it should? The Lifetime Isa rules already remove the tax benefit of the bonus on subscriptions when withdrawals are made before age 60. Isas have always allowed withdrawals at any age, so why introduce an additional early withdrawal exit charge on top?
It appears there will be no formal consultation on the rules surrounding the Lifetime Isa, meaning a clear opportunity for the wider industry to challenge the Government on aspects of its design will be missing.
In the absence of this formal opportunity for scrutiny, the Government should confirm why a 5 per cent exit charge is appropriate – that way we can have a proper debate about its merits.
Gareth James is head of technical resources at AJ Bell