Last week I looked at the fundamentals of the Lifetime Isa based on what we have so far – and that is not much. The draft legislation is awaited with interest. I would now like to consider how the Lifetime Isa might work as an alternative to pension provision, the unspoken role for which it may well have been designed. I would like to thank John Housden, a provider of invaluable insight to Technical Connection, for a lot of the thinking behind this.
First off, it is worth noting that the 25 per cent government bonus is not quite the same as basic rate relief:
- The bonus will be paid at the end of the tax year and there is no indication that monthly interim claims will be possible, unlike the way pension relief at source operates. How this will work in the real world remains to be seen. It is hard to envisage the Lifetime Isa bonus arriving on 5 April for a payment made that day. So there may be an extra delay (remember contracting out rebates?). In theory this will mean that, for the same outlay, a Lifetime Isa will produce a marginally smaller fund than a pension because part of the investment will be deferred, whereas pension relief at source is either provided instantly or with a delay of no more than about eight weeks.
- The government bonus stops at age 50, 10 years before the Lifetime Isa is generally accessible without penalty, other than for first home purchase (or “other specific life events”, as yet undefined).
- Contributions are personal payments. As with existing Isas, this would probably mean that a contribution paid by an employer can be accepted, provided the employer confirms the payment will be treated as a relevant payment to an employee for the purposes of the PAYE regulations and a payment of earnings for the purposes of Class 1 NIC (para 6.7 ISA Guidance Notes).
For comparison purposes, let us look at various tax rates initially and at age 60, with four situations:
- A £1,000 contribution to a Lifetime Isa, made before age 50 and attracting a £250 bonus.
- A £1,000 net contribution to a personal pension made directly by an individual, equivalent to £1,250 gross for a basic rate taxpayer, £1,666.67 for a higher rate taxpayer and £1,818.18 for an additional rate taxpayer.
- A salary sacrifice of £1,000 net income (allowing for income tax and employee NICs) funding a PP with no employer’s NIC boost.
- A salary sacrifice of £1,000 net income (allowing for income tax and employee NICs) funding a PP with full (13.8 per cent) employer’s NIC boost.
To keep matters simple, all growth is ignored (although the Lifetime Isa would produce marginally less than a PP, as explained above). The pension is valued as if the entire fund were drawn as an uncrystallised funds pension lump sum.
The Lifetime Isa compares favourably for a basic rate taxpayer (as many of the under-40s will be) if direct contributions are compared. Once salary sacrifice (or employer contributions, for that matter) are considered the picture is less clear cut. In theory, there is always the option of using the Lifetime Isa to fund pension contributions from age 60, thereby grabbing both the Lifetime Isa government bonus and tax relief. In practice that means relying on the current pension tax system continuing beyond 2037, which looks somewhat unlikely.
Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn