George Osborne’s Lifetime Isa has been hailed both as a boost to the saving prospects of the young and self-employed, while also signalling the destruction of the pension as we know it.
Experts warn specialist automatic enrolment providers’ business models are under threat as young people disregard financial common sense in favour of unrivalled flexibility.
There are also fears, first raised as part of the consultation on tax relief reform, investors are at the whim of future governments who may decide to reverse the rules and tax the Lifetime Isa when it is withdrawn.
The Chancellor also faces a backlash over the inclusion of a 5 per cent early exit fee just weeks after providers have scrapped penalties in response to pressure from the Government and the FCA.
Providers warn costs to investors could spiral if the Government follows the US model of ultra-flexibility.
So who wins and loses from the Lifetime Isa? Money Marketing picks apart a policy that has the potential to redraw the savings and investment landscape.
Once in a lifetime
In the face of a backbench rebellion and furious industry lobbying Osborne ditched plans to use last week’s Budget to flip the pension tax system on its head.
Instead he unveiled the Lifetime Isa, a product for the under-40s that looks remarkably like the kind of top-up savings system the Chancellor is believed to favour over the existing tax relief model.
From next April people under 40 will be able to put away £4,000 a year from taxed income until they reach 50. The Government will top-up investments by 25 per cent and withdrawals will be tax-free. However, a 5 per cent exit fee – and the Government top-up along with any corresponding investment growth – will be clawed back if cash is accessed before 60 and is not used to fund a first-time property purchase. savers diagnosed with a terminal illness can withdraw funds tax-free regardless of age.
Osborne said: “For the basic rate taxpayer, that is the equivalent of tax-free savings into a pension, and, unlike a pension, you won’t pay tax when you come to take your money out in retirement.
“For the self-employed, it’s the kind of support they simply cannot get from the pensions system today.”
And he hinted the Government may follow the US, where funds can be reinvested if accessed early.
“We’re going to consult with the industry on whether, like the American 401K, you can return money to the account to reclaim the bonus – so it is both generous and completely flexible.”
But experts say adding in flexibility will ramp up costs.
The Lang Cat principal Mark Polson says: “There will be heads of operations across the country sitting in padded rooms right now.
“The conditions they are putting on the way in and out make the Lifetime Isa extremely cumbersome to administer. You have got quite a lot of tracking to do so, for example, when you cash it in and lose the bonus, the Government says you lose all the growth on that bonus. But what if you’ve invested in different funds, how do you attribute that across the funds? You’d have to track different pots – those that include the bonus and those that don’t.
“Then there’s the limit on the property purchase. You can only use it for properties up to £450,000 but how do you monitor that? Does that need to be verified by a solicitor? In which case who pays?
“From a provider standpoint, it shoves a load of complexity and cost in and in the main, in the early years, you will be dealing with quite small pots. I suspect these are not going to be terribly attractive for providers to get involved with.”
Aviva head of financial research John Lawson says: “The administration expense of making payments and reinvesting and adding the Government bonus, that all adds up to additional costs so I would caution against having a super-flexible system.
“To run two separate products side by side is probably a good compromise because if you add that flexibility into the existing pension rules that adds a huge amount of complexity. It makes administration very difficult and expensive, and pushes up the price of pensions.”
Standard Life is one of several providers already committed to offering the Lifetime Isa. Head of pensions strategy Jamie Jenkins thinks Isa costs could be driven down. He says: “At the moment the charges within pensions have been coming down and are generally cheaper than on Isas. That’s probably explained by how long people tend to hold Isas as opposed to pensions. There’s a question as to whether that starts to even out as a result and charges come more into line.”
While firms that plan to offer both workplace pensions and the Lifetime Isa welcome the launch, specialist providers are more wary.
Former pensions minister now Royal London director of policy Steve Webb slammed the Government’s “rival product” which he says risks causing “mass confusion”. However, the mutual will not rule out offering it.
Auto-enrolment firm The People’s Pension has also warned people are “stretched financially, and the att-raction of the flexibility offered by a Lifetime Isa may make it an either/or for savers”.
Now: Pensions director of policy Adrian Boulding says the Treasury is “naive” to expect auto-enrolment pensions and Lifetime Isas to exist in isolation. He predicts employers will want a provider which offers both products in the workplace.
He says: “When we get to 8 per cent contributions, not many people will be able to contribute the full amount and £4,000 into a Lifetime Isa as well. They are going to have to choose. The numbers say the pension is worth more but the behavioural aspects back the Lifetime Isa – people like the earlier goals and it is refundable.
“The pivotal role is employers. Some will say we just do pensions through auto-enrolment and nothing else. But some will say we have a workplace Lifetime Isa and people can pay into that, and we can do things like payroll deduction.
“A third group will say if you want to go into the Lifetime Isa and opt out of the pension plan we will pay your contributions in there as well. That could be quite popular. Would employers want to have a pension provider and an Isa provider? Or would you want the whole lot from one shop on the same platform?”
There have long been question marks over the long-term sustainability of providers who are restricted to a 0.75 per cent charge cap.
Throwing the Lifetime Isa into the mix raises further issues. A spike in auto-enrolment opt-outs would place a strain on all providers’ business models, including Government-backed pension scheme Nest, which is already under pressure to repay its £387m Department for Work and Pensions loan.
A Nest spokeswoman says: “The policy is only a few days old and we’re working through the implications, many of which won’t become clear for quite some time. We’d want to provide a considered response rather than speculate.”
Death of the pension?
Prior to the Budget the Treasury briefed journalists that plans to radically redraw the pensions system, most likely to a flat rate of relief or a pension Isa model, would be paused.
However, the launch of the Lifetime Isa signals the Chancellor has not given up on his ambition to eventually bank billions a year by abolishing upfront tax relief.
While both the Lifetime Isa and current pension systems run in tandem the first people to access their Isa pots – in 20 years’ time – will be able to exploit both regimes.
Helm Godfrey chairman Danby Bloch says: “There is nothing to stop someone from taking their Lifetime Isa funds – or indeed any Isa funds – cashing them and then recycling them into a pension before drawing the retirement income. You might ask why give up the carefree life of drawing tax-free income for life. And the answer is the tax relief might make it a worthwhile proposition – depending on circumstances.
“In time, all other Isas will disappear leaving everyone with a single savings vehicle to serve from cradle to grave”
“As always the more tax relief that can be engineered on the contribution to the pension, the better. And it is especially worthwhile if the inv-estor gets 40 per cent tax relief on the contribution and then pays just 20 per cent on the taxable pension income. So, ignoring costs, £10,000 gross contribution costs a higher rate taxpayer £6,000 net of tax relief and then if they draw the benefit as a basic rate taxpayer, they will get £2,500 tax-free lump sum and £7,500 taxed at 20 per cent. So a net input of £6,000 turns into possible net proceeds of £8,500 giving a 41.7 per cent return.”
The Government will not be exp-osed to this recycling risk until 2037 at the earliest but many think the system will be torn up long before then.
Centre for Policy Studies research fellow Michael Johnson is a leading advocate for abolishing tax relief and making withdrawals tax-free.
He says: “The next step is to introduce the workplace Isa. In time, all other Isas will disappear leaving everyone with a single savings vehicle to serve from cradle to grave.”
A trojan horse for sweeping changes to pension system
The direction of travel for pensions policy has been set by the introduction of the Lifetime Isa. This could be the Trojan horse to end pension saving as we know it.
We suspect the Chancellor would have liked to have gone further in this Budget but political sensitivities made that too risky. It is highly likely, over time, the Government will morph the Lifetime Isa into a pension Isa, significantly reducing the tax relief incentives it provides.
Lifetime Isas will be attractive to many who want to have a more flexible way of saving. They are particularly attractive for those in the 20 per cent tax bracket. High-flyers, who may be in the 40 per cent bracket but are worried their pension savings could breach the annual and lifetime allowance limits, should also take note. Everyone under the age of 40 should open one as a form of insurance against hitting pension savings limits in the future.
However, some points require careful consideration.
While Lifetime Isas come with an incentive in the form of a Government top-up they also come with penalties for early access. Pensions also come with strong incentives to save in the form of tax relief and employer matching contributions.
After so much effort has gone into the introduction of auto-enrolment, with many employers offering good matching rates, we need to ensure people continue to understand the value of that and do not give it up. Saving into a pension with an employer contribution generally remains the best route for most.
A clear investment strategy will be crucial. Around 80 per cent of Isa money is held in cash. If people put long-term savings into only cash they could lose up to 60 per cent of value compared with a more balanced investment strategy.
A few days before the Budget the FCA released findings from the Financial Advice Market Review. Essentially, it is looking for employers to take a more active role in educating staff around retirement.
The Budget then increased the amount employers can contribute (tax-free) to advice from £150 to £500. It is a clear sign the Government is looking for employers to play a more active role supporting employees to understand the choices they have. With the Lifetime Isa, employees have more choices than ever.
The Government forecasts a large fiscal consolidation the year before the next election – it’s hard to see how pension tax relief will not have a role to play. Running Lifetime Isas in parallel with the current regime undoubtedly smooths the way for more radical change when the political environment is less risky.
Chris Noon is a partner at Hymans Robertson