Those of us in the pensions world were waiting to see if there would be a sting in the tail of the Chancellor’s assurance he was not going for a full-scale reform of pension tax relief in last week’s Budget. Would he cut the lifetime and annual allowances further? Would he abolish salary sacrifice for pensions? Would he launch a pension Isa despite not going for full-blown reform?
On the first two there is no change. But we did get the pension Isa in a slightly different form to what we were expecting.
For a basic rate taxpayer, the Lifetime Isa offers the same level of tax incentive as saving into a pension but has two distinct advantages. First, funds can be withdrawn to purchase the saver’s first home and, second, funds can be withdrawn completely free of tax if held to age 60.
The naysayers were quick to suggest the Lifetime Isa would undermine automatic enrolment and criticised it for further complicating the savings landscape. Of course, more products bring more complexity but the choice between workplace pensions and the Lifetime Isa is pretty straightforward. It will be driven by two things: savings priorities and tax rate expectations.
It has also been suggested the Lifetime Isa will tempt young people out of workplace pensions because they will prefer the ability to buy their first home. However, this seems to have cause and effect the wrong way round.
Those who are determined to buy their own home but cannot afford to do so and contribute to their workplace pension will surely opt out of the pension in any case. The Lifetime Isa just gives them a product they can save in more tax-effectively. The younger generation need all the help they can get to get on the property ladder, so this seems like a welcome boost.
Obviously, the availability of the employer contribution under auto- enrolment means it is generally best advice for people to stay in the scheme and maximise their personal contributions to the extent these are matched by the employer. But what then? Simple maths shows for most basic rate taxpayers additional pension saving is far less attractive than saving into a Lifetime Isa.
A basic rate taxpayer putting £800 into a pension will get £200 relief, giving them £1,000. When this is taken out, 25 per cent is tax-free and the rest is taxed as income. If the individual is still a basic rate taxpayer in retirement they will get £850 out of the pension overall, giving a measly 6 per cent uplift on their original £800 investment. Worse still, if they are a higher rate taxpayer they will get only £700, meaning they have lost 12.5 per cent of their investment.
Under a Lifetime Isa, both would have got £1,000 at retirement, giving a 25 per cent uplift on the original investment. Compared with a pension, the basic rate taxpayer is nearly 18 per cent better off and the higher rate taxpayer is 43 per cent better off. So the Lifetime Isa wins hands down.
For people that are higher rate taxpayers today, the choice is more complicated. If they expect to be basic rate taxpayers in retirement, then the pension is the better option, delivering a 42 per cent uplift on any personal contribution. If they remain a higher rate taxpayer, then the Lifetime Isa wins again, offering a 7 per cent better outcome than the pension.
In summary, then, while employer-sponsored pensions are very much worth having, the Lifetime Isa offers a very attractive alternative for additional saving. Yes you cannot get at it until you are 60 but remember the minimum pension age will be at least 58 by the time any Lifetime Isa investors retire, so this is a non-issue.
Can you trust the Government not to renege on the promise to pay benefits tax-free? It would be a lot harder politically to introduce a tax where none previously existed than to fiddle around with existing allowances and rates. After all, this is what we have seen in almost every Budget for the past 10 years.
So let’s welcome the Lifetime Isa for what it is: a really valuable way of saving for those who do not currently get significant benefits from pensions tax relief. Does it spell the end of pensions? I doubt it. But it certainly points the way to how we can make saving more than the minimum for retirement the norm.
Richard Parkin is head of pensions at Fidelity International