We welcomed the launch of the Lifetime Isa, not least because of the generous tax benefits it offers, especially to those on lower earnings. These tax benefits are better than those available on pensions for many people, which raises the question of whether the Lifetime Isa should replace pensions as the preferred way of saving for retirement.
The availability of the employer contribution under automatic enrolment means joining an employer-sponsored pension scheme remains the best option for those saving for retirement. Come April 2019, the employer contribution plus the tax benefits delivers a return of 70 per cent on a net contribution for a basic rate taxpayer under auto-enrolment. Compared with the 25 per cent tax benefit under the Lifetime Isa, employer-sponsored pensions win hands down.
But what does the comparison look like when there is no employer support? The tax-benefits of pensions for those on basic rate tax in employment are, at best, the same as the Lifetime Isa if they are a non-taxpayer in retirement. If, as is more likely, they are paying basic rate tax on at least part of their income, the Lifetime Isa beats pension. For today’s higher rate taxpayers the pension tends to win.
All this presents a challenge for employers operating pension plans. If they are to do the right thing by their employees, they will need to help people understand when each option will be best. For basic rate taxpayers, this is reasonably straightforward. Once they have exhausted the employer’s matching contributions they should switch to a Lifetime Isa.
When it comes to working out what to say to higher rate taxpayers, it all looks very complicated. But it need not be so. Despite raising concerns about salary sacrifice before the Budget, the Treasury confirmed it would be maintaining the facility for pension saving. Salary sacrifice involves swapping part of an employee’s salary for pension contributions. This avoids the employee paying National Insurance on this amount and also gives the employer a NI saving. Because NI is highest for basic rate taxpayers (12 per cent) the effect for this group is significant. In fact the benefit of salary sacrifice puts pension saving back on a par with the Lifetime Isa.
For a basic rate taxpayer looking to get £1,000 after tax at retirement, the cost is only £800 net for the employee, the same as for the Life-time Isa. For a higher rate taxpayer who remains on the higher rate in retirement, the figure is £828, and for those who receive higher rate relief but are then on basic rate in retirement, this figure falls to £682.
This analysis assumes there is no sharing of the employer NI saving with the employee. If the employer were to give up just 2 per cent of the 13.8 per cent NI saving they make, then the pension wins all round.
Salary sacrifice is not straightforward to administer and has knock-on implications for other benefits. However, for some employers it may be the preferred approach for helping employees make the most of the tax incentives on offer.
Richard Parkin is head of pensions at Fidelity Internationa