As the Treasury ponders letting people borrow from their Lifetime Isa, data from the US reveals how savers have responded to decades of being able to take loans from their pensions.
Chancellor George Osborne is enthusiastic about the idea, but pensions and investment firms warn borrowing could raise fees, put off savers and leave others falling short of money in retirement.
So, should savers be free to borrow from their Lifetime Isa, or even from their pension? And what impact would that have on contribution rates, retirement income and costs?
The US experience
When the Government unveiled the Lifetime Isa in March, the Chancellor added: “We’re going to consult with the industry on whether, like the American 401(k), you can return money to the account to reclaim the bonus – so it is both generous and completely flexible.”
In the months since then the Treasury has been informally consulting on how the Lifetime Isa will work in practice.
Among the key sticking points are the inclusion of a 5 per cent penalty for early access, the Government top-up being applied annually, and whether or not borrowing should be allowed.
The latest data from the US, published in April but covering about 20 years up to 2015, shows some 87 per cent of occupational pension customers have the ability to borrow from their 401(k)s.
The analysis, by the Employee Benefit Research Institute and the Investment Company Institute, shows that historically about a fifth of savers with access to borrowing had outstanding loans.
At the end of 2014 the average proportion of loan to remaining pension savings was 11 per cent, with younger people typically borrowing larger amounts from their pots.
Most plans allow loans of up to £50,000, or 50 per cent of the value of their account.
Fairer Finance managing director James Daley says: “I don’t have any real problem with the idea of people borrowing from their Lifetime Isas –or their pensions.”
“The big danger with the Lifetime Isa rules is that they end up complicating an otherwise simple product, and complication nearly always puts investors off”
He adds: “If you’re borrowing responsibly, then taking money from your pension or Lifetime Isa may be absolutely the most sensible thing to do – particularly if the savings on alternative forms of borrowing are significant.”
However, there are concerns the attractions of the Lifetime Isa could draw savings away from pensions if people opt out of auto-enrolment schemes as a result. Crucially, auto-enrolment includes an employer contribution as well as tax relief, while the Lifetime Isa only has a 25 per cent bonus added to savings up to £4,000 a year.
The Work and Pensions committee has opened an inquiry into the issue and is due to report on its findings in the coming weeks.
AJ Bell head of platform technical Mike Morrison says: “The big danger with the Lifetime Isa rules is that they end up complicating an otherwise simple product, and complication nearly always puts investors off.
“Experience from 401(k) schemes in the US suggests that allowing borrowing increases participation in and boosts contribution rates. However, it also shows that it is often those with the least money saved and on the lowest salaries who take out a bigger proportion of their pot. There will also be cases where people have taken out loans and never paid them back.
“In the UK there is a risk that savers tempted by the option of borrowing from their Lifetime Isa will regret any decision to opt out of auto-enrolment when they come to retire.”
Tisa policy strategy director Adrian Boulding says: “They are supposed to be individual savings accounts, not individual borrowing accounts.
“We don’t support borrowing from Lifetime Isas as building the infrastructure will impose a large and unwarranted cost on Isa providers which will feed back to consumers as higher charges and lower returns.”
He adds that the Isa allowance is now large enough at £15,000 a year to allow savers to cash them in if they need short-term cash.
Boulding says instead of allowing borrowing the Government should scrap the 5 per cent exit charge, which he argues is “way out of line with the industry” and a “thing of the past”.
However, fears that savers could take out loans only to default on them may be overstated, according to figures from Fidelity Investments.
In the US, loan repayments are paid automatically via payroll, helping to keep default rates “relatively low” says sister company Fidelity International head of pensions Richard Parkin.
But he warns defaults increase in cases where the individual leaves an employer. In this case the loan must be repaid within 90 days before the outstanding balance is treated as a withdrawal and taxed as income in addition to a 10 per cent penalty.
The Fidelity data also shows people taking out loans are more likely to reduce their normal pension contributions. A quarter (25 per cent) reduced contributions in the five years after taking out a loan, while 15 per cent ceased contributions entirely.
Parkin says: “Combined with having assets out of the market, this can have a significant impact on retirement preparedness.”
Yvonne Goodwin Wealth Management managing director Yvonne Goodwin says: “It’s OK being able to borrow, but what are the implications of then paying it back? Will they make the payments, or will they fall on the welfare state?
“The problem is a lot of hyperbolic discounting goes on. If people are sensible and plan it’s not a bad idea, but if they just take it because it is something they want now then there could be a problem.”
Dobson and Hodge director Paul Stocks says: “Flexibility is good but it inevitably comes with complications. One of the biggest hurdles with pensions was people thinking their money was tied up and now the new freedoms rules have removed that. You can already take money out of normal Isas and adding these features will only increase the cost to providers and, ultimately, consumers.”
A Treasury spokeswoman says: “The Government is committed to creating a nation of savers. Our new Lifetime Isa will give people greater freedom and choice to save flexibly for the long term in a way that works for them. We continue to engage with industry about how the Lifetime Isa will work in detail”.
Americans saving into 401(k) plans that allow loans
Proportion of people in borrowing-enabled plans who had loans outstanding
Average unpaid balance
Source: 401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2014, Employee Benefit Research Institute and the Investment Company Institute (April 2016)