Young workers will no longer have to choose between saving for a home or retirement, as the Chancellor revealed a new Lifetime Isa with a bonus of up to £1,000 a year in his Budget.
The new Lifetime Isa – which can be invested in stocks and shares or cash savings – will be launched next April to help people aged 18 to 40 get a foot on the housing ladder, without hindering their efforts to put aside money for their pension
Savers can tap into their bonus pot if they use some or all of the money to buy their first home, or wait until they are 60 to withdraw cash and their bonus tax-free, according to George Osborne, who unveiled the measure in today’s Budget.
Even more help to buy: Young workers will no longer have to choose between saving for a home or retirement, with the new lifetime Isa
The savings and the bonus can be used towards a deposit on a first home worth up to £450,000 – and the deal allows two first-time buyers to both earn bonuses then pool their resources to buy a home.
Those aged under 40 can open a Lifetime Isa and save up to £4,000 a year into it to get a maximum £1,000 bonus, with a £1 top-up for every £4 that they save. They will get this for every year that they save money until age 50.
The Chancellor also delivered a huge hike in the overall annual Isa allowance from £15,000 to £20,000, with the new Lifetime Isa pot falling under this umbrella.
Those with a Help to Buy can transfer those savings into a Lifetime Isa when they are launched in 2017, or continue saving into both. However, you can only use the bonus from one to buy a house. The Help to Buy Isa will be axed in November 2019.
Those who prefer to use the allowance to save for retirement, can take out all the savings tax-free when they are 60 and get their Lifetime Isa bonus paid out.
But there will be fairly stiff penalties for making withdrawals from a Lifetime Isa for anything other than buying a home.
You can cash in at any time before you turn 60, but you lose the government bonus and any interest or growth on this, plus savers doing this will have to pay a 5 per cent charge.
But in addition to withdrawing your money from the Lifetime Isa to buy a home, you can also do so without penalty if you fall terminally ill.
Rabbit out of the hat: George Osborne’s new Lifetime Isa was a surprise Budget move today
The Treasury confirmed to This is Money that all savers aged under 40 will be able to open a Lifetime Isa, even those who already own a home and are saving into a pension.
This opens up the door for investors who can find the money to benefit from both tax relief on pension contributions and the bonus on a Lifetime Isa
However, only saving for retirement through a Lifetime Isa could be less attractive than an ordinary pension where you save from untaxed income – the Government pays tax relief at your 20 per cent, 40 per cent or 45 per cent income tax rate. If it is a workplace pension, your employer makes contributions too.
The Lifetime Isa bonus is the same as tax relief on pensions for basic rate taxpayers but lower than that on offer for higher rate taxpayers.
Chancellor George Osborne was recently forced to ditch radical plans to axe tax relief and introduce a Pensions Isa for everyone, for fear of a backlash from voters ahead of the Brexit referendum.
The Lifetime Isa likely to be see as a half-way measure, possibly laying the groundwork for extending it once the EU referendum is over.
THE LIFETIME ISA AT A GLANCE
Who can open a Lifetime Isa?
The new Lifetime Isa can be opened by those aged under 40 in April 2017 and use it to invest in stocks and shares or for cash savings.
What will it offer?
Savers can put in up to £4,000 a year to qualify from a maximum government bonus of £1,000 – contributions will get this 25 per cent top-up every year until age 50. This is a £1 bonus for every £4 that you save.
How do I get the bonus?
The bonus will be paid on some or all money taken out to buy a first home, or after the age of 60.
What if I need the money earlier?
Money taken out of the Lifetime Isa before age 60 for anything other than a first home will lose the government bonus, all interest or stock market growth delivered by that element, and face a 5 per cent charge.
Can someone under 40 start save into a Lifetime Isa as well as a pension?
Yes, the two are separate and designed to complement each other. They will get both a Lifetime Isa bonus and tax relief on their pension?
Does the annual Lifetime Isa allowance fall within the new total £20,000 Isa umbrella?
Yes, the new £20,000 Isa allowance – raised from just over £15,000 now – includes money put into a Lifetime Isa, cash Isa, stocks and shares Isa and the new Innovative Isa.
Can someone who is already a homeowner get a Lifetime Isa?
Yes, it is open to all those aged under 40 in April 2017
The idea has won broadly favourable reviews from financial industry experts, with some caveats.
David Harrison, of online investment site True Potential Investor said: ‘Isa are the key to closing the savings gap and turbo-charging them is a huge step in the right direction.
‘We called for a top-up and a higher annual limit and the Chancellor has delivered both. This is excellent news and will change the way the nation saves for the better.’
The Chancellor will hope that the added flexibility of the new Lifetime Isa will attract younger savers to take them up, as if the scheme diverts higher rate taxpayers’ savings from pensions it could save him a substantial sum on pension tax relief.
Phil Wadsworth, chief actuary at JLT Employee Benefits, said: ‘Are new attractive Isas set to take over pensions? Getting one pound for every four is a straightforward incentive to save.
‘Coincidentally, it is the equivalent of pension tax relief for a basic rate tax payer. The fact that Lifetime Isas are much more flexible means younger people will likely find it more attractive than pension savings.’
Nick Hungerford, chief executive of Nutmeg, said: ‘Customers need to make sure they understand the Lifetime Isa. The Lifetime Isa comes with early exit fees of 5 per cent – those could sting savers who expected the product to offer full flexibility.
‘We also wonder whether the Lifetime Isa will lead more people to direct savings towards a property, leaving less money for pension savings. So as with all investments, savers should read the small print.
Workplace pension advantage: Only saving for retirement through a Lifetime Isa could be less attractive than an ordinary pension where you save from untaxed income, and your employer makes contributions too
‘It’s possible that this is the beginning of a new shift, away from pensions as a long-term savings vehicle and towards Isas. Isas are a trusted brand, and people understand them better than they understand pensions.
‘Certainly, from the government’s point of view, there is a strong fiscal incentive to encourage people to save into ISAs, not pensions – it means less tax relief to pay out during the remaining four years of this government.’
Jamie Smith-Thompson, managing director of Portal Financial, says: ‘This was a fairly cautious Budget, with the announcements no doubt influenced by the EU referendum. We can all breathe a sigh of relief that the radical changes to pensions did not happen, and it is great news for savers that the 25 per cent tax-free lump sum is not being abolished or restricted.
‘The chancellor appears to have a clear mission to simplify and encourage personal saving and reduce the role of the state. The lifetime ISA is essentially what people expected the pension ISA to be, and it is another incentive for people to save, which can only be a good thing.
‘With a higher minimum age and lower annual contribution limit, the lifetime ISA is not a competition for pensions, so people do not need to decide between the two.
‘I suspect that most people will use the Isa for house deposits, while auto-enrolment will be the main vehicle for retirement savings. Taken together, people have a good opportunity to be in very strong positions when they leave the workforce.’
SHOULD YOU SAVE INTO A LIFETIME ISA OR STICK WITH A TRADITIONAL PENSION?
The advantages are:
* You can save towards two big life goals, a home and retirement, without locking up money into a pension until you are aged 55
* Isas are simple, easy to understand products
* You get a Government bonus going in, equivalent to basic rate tax relief, and then withdrawals are tax free as well
* A nifty bit of arithmetic by Legal and General Investment Management shows that if a 25 year-old started a Lifetime Isa and contributed £4,000 a year combined with £1,000 from the Government and 5 per cent annual growth, that would equal a tax-free pot of over £416,000 at age 60.
The disadvantages are:
* There is a 5 per cent penalty on withdrawals and you will lose your bonus and any interest earned on it, unless you use the money for a home, become terminally ill, or wait until you are 60
* Your employer won’t be able to make any contributions, which is a big perk of workplace pensions
* You can’t earn any more bonuses from a Lifetime Isa after you reach the age of 50
* You can access your pension at age 55, but with a Lifetime Isa you have to wait until 60 if you want to keep the bonus and avoid the penalty
* The bonus is equivalent to pension tax relief of 20 per cent for basic rate taxpayers, but looks less attractive to higher earners who get tax relief at 40 per cent or 45 per cent.
Adrian Walker, retirement planning expert at Old Mutual Wealth, was more sceptical about the plans. He said: ‘The Lifetime Isa is a gimmick that will only appeal to younger savers looking for help getting on the housing ladder. Very few people will use a Lifetime Isa to save for old age and pensions are still the best retirement savings vehicle.
‘The £1 bonus for every £4 is parity with the basic rate relief you currently receive on a pension, but crucially without employer contributions. Younger savers will also have to place faith in future governments not to renege on the promise of a bonus at age 60.
‘The link with retirement savings indicated in George Osborne’s Budget speech is not reflected in the detail of the policy proposal. Of greater concern is whether the Lifetime Isa is a precursor to either a 20 per cent flat rate of pension tax relief or the Pension Isa.
‘If government finances deteriorate further, the Chancellor may be tempted to extend its reach, allowing Government to slash pension tax relief or benefit from income tax on pension contributions upfront. It could be a prototype for the pension system of the future.’
Patrick Bloomfield, partner at Hymans Robertson, estimated that if everyone under 40 switched to a Lifetime Isa, the Treasury would net £1billion per year.
He said: ‘It’s interesting that the Chancellor said he would not let the next generation pick up the bill for decisions made today. It could be fair to say that the introduction of the Lifetime Isa is not putting the next generation’s needs first.
Foot on the ladder: Lifetime Isa savings and the 25 per cent bonus can be used towards a deposit on a first home worth up to £450,000
‘We’ll be enjoying the tax take that would have gone to our children and grandchildren as the Government will receive tax and National Insurance earlier. Essentially the Government will be taking 15p in the £1 up front.
‘It could also be a forerunner to the end of pensions as we know it. It’s essentially a new pension regime through the backdoor and the first step on the path to a pensions isa for all.
‘The under 40s currently make £17billion of contributions into defined contribution schemes. If everyone made the switch to a Lifetime Isa, and they followed the same behaviours of ISA investors, putting 80 per cent into cash, then that could be several billions pounds lost in investment returns every year.’
John Blowers, head of Trustnet Direct, said: ‘These changes to Isa limits and especially the introduction of the new lifetime Isa with that 25 per cent bonus really do look like the pension reforms many had feared, just wrapped up in something of a Trojan horse.
‘Those higher rate taxpayers who topped up pension contributions in haste just a few weeks ago probably don’t have much to worry about – it seems inevitable that the current structure’s generosity cannot be sustained and the end goal appears to be a Pension/Isa hybrid, and that’s going to appeal to politicians right across the spectrum.’
Richard Parkin, head of pensions at Fidelity International, said: We welcome any changes that encourages and incentives saving for the longer term – particularly those in the younger age group who are facing real struggles between saving for a pension and saving to get on the property ladder.
‘Talk of these changes signifying the death of pensions is overdone. For most people, they would still be best advised to use auto-enrolment and benefit from the matching employer contribution.
‘These changes will be good for people who are lucky to have additional funds that they wish to save outside of auto-enrolment or who want to have a boost to their housing fund.’