The introduction of LISAs in April could undermine auto-enrolment and is unlikely to be the last change to the retirement saving system
There were relatively few of George Osborne’s trademark rabbit-out-of-a-hat moments in what turned out to be his last Budget. There were a few targeted give-aways and a tax on sugary drinks, but the measure that could yet have the most lasting consequences was the launch of the Lifetime ISA, or LISA.
This was actually a watered down version of the major overhaul of pensions tax treatment trailed ahead of the March showpiece. Many had expected the then-Chancellor to announce a wholesale move from a system that gave tax relief on pension contributions to one where savers contributed out of taxed earnings, but enjoyed tax-free income in retirement.
Ahead of the Budget, the retirement saving sector warned such a move would prove damaging. The Pensions and Lifetime Savings Association said it would boost government coffers in the short term but ultimately lead to lower saving levels.
There are still concerns the product could have an impact on the government’s flagship pensions policy
So the unveiling of the LISA – a vehicle for under-40s with government incentives to encourage them to save for a first house or to fund retirement led to sighs of relief. But there are still concerns the product could have an impact on auto-enrolment – the government’s flagship pensions policy.
So how will LISAs affect retirement savings when they come onto the market in April? And could these products be the first step towards the more fundamental change to the tax system mooted ahead of the last Budget?
What is the LISA?
The Lifetime ISA is a saving vehicle designed to provide people with money to buy their first home or to fund their retirement.
Savers can only open a LISA between the ages of 18 and 40, but they can continue paying into one until the age of 50.
They can pay in up to £4,000 a year, and will receive a 25% government top up. This will be paid at the end of the first year and monthly from 2018/19.
Anyone withdrawing money before the age of 60 for any reason other than to buy a first home will lose 25% of their savings (the government top up plus a 5% penalty) unless they are terminally ill.
After 60, they can access their cash tax free.
There are several concerns about the LISAs. They could divert savings away from pensions into housing, are unlikely to be suitable retirement saving vehicles, and will complicate the savings landscape further.
Any product is a competing product with pensions when there’s a finite amount of money
Pensions minister Richard Harrington believes worries the LISA will siphon money away from traditional retirement saving are overblown, however. Speaking at the Trades Union Congress conference in February, he explained: “Any product is a competing product with pensions when there’s a finite amount of money. But in reality there is a huge difference between the LISA and a pension, and that is the employers’ contribution.”
Harrington recognised that the proliferation of saving vehicles on offer could confuse workers. But he added: “The big one, without any doubt, is the workplace pension because it is given to them on a plate. It’s exponentially better because the employers are involved with it.”
His predecessor Baroness Altmann is not so sure the policy will prove benign. She warns that the LISA is a “classic example of how not to make pensions policy” – and it is difficult to see how younger workers won’t be forced to choose between contributing to a LISA or an auto-enrolment pension.
If it is popular the LISA does have the potential to undermine the whole auto-enrolment regime
Sackers Partner Fuat Sami says: “If it is popular the LISA does have the potential to undermine the whole auto-enrolment regime because many younger people won’t have enough money to pay into two saving vehicles.”
And there are signs that LISAs could be very popular with savers, particularly in property price hotspots like London. Research commissioned by Hymans Robertson found that 61% of under-40s would consider opening one, with 23% saying they would do so right away. In the capital 37% were impatient to start contributing to a LISA.
The housing market is dysfunctional and people are haemorrhaging cash paying rent
“We know the housing market is dysfunctional and people are haemorrhaging cash paying rent,” says Like Minds senior partner Trevor Rutter. “So all logic says this is going to be popular, because it has a nice simple message – the government will pay off 25% of your mortgage deposit.”
But the take up of LISA depends on more than popularity with consumers. Providers have to offer LISA products, and employers have to give staff easy access. But only one major provider – Hargreaves Lansdown – is planning to launch a product in time for April, with others planning to join the market later.
There has been a lot of silence from the government, which doesn’t fill the industry with confidence
“We haven’t seen that many providers committing to launching in April,” says Barnett Waddingham head of DC Mark Futcher. “There has been a lot of silence from the government, which doesn’t fill the industry with confidence to go out and spend the money to develop these products.”
On the other hand Futcher says employers are attracted to the LISA, with around 30-40% of his clients keen to offer the option to workers. “But they’re not going to go to much hassle to do it,” he says, “so they will probably wait for their pension provider to have an offering.”
Top ups v tax relief
So if workers are eager to open LISAs, and many firms want to offer them, perhaps all will be well once providers catch up with this appetite.
A worker paying basic rate tax would need to pay £80 to get £100 in their pot under either system
But there are worries that many people will fail to grasp the value of what they are losing by opting out of a pension. The 25% ‘bonus’ is an easier sell than tax relief, which is poorly understood, but the end result is the same: a worker paying basic rate tax would need to pay £80 to get £100 in their pot under either system. Anyone paying higher rate tax would only need to put £60 into their pension to get the same result. (Given that Futcher says most interest has come from City firms, this is potentially significant).
Savers who opt out of a workplace pension will also lose matching employer contributions, and if their firm uses salary sacrifice will end up paying more National Insurance. So the chances are savers will lose out by on ‘free money’.
Although former minister Altmann is encouraged by steps the Financial Conduct Authority is taking to improve consumer protection, she warns these will not help people understand the value of what they’re giving up.
It also seems likely that LISA investment strategies will be geared towards liquidity and volatility control rather than growth, which is ideal for short-term saving, but not for building up a retirement pot.
The LISA is fine if you are saving for a house, but as an alternative to a pension it is fraught with risks
“The LISA is fine if you are saving for a house, but as an alternative to a pension it is fraught with risks that savers may or may not understand,” says Altmann. “There is a real danger that the government could end up with a misselling scandal on its hands.”
So a lot of responsibility will fall on employers to make sure their workers are sufficiently well informed.
It’s not necessarily a bad thing to save into a LISA, as long as people are making informed choices
“We are encouraging our clients to start talking to their employees about having a short- medium-term and long-term view of their finances,” says Like Mind’s Rutter. “It’s not necessarily a bad thing to save into a LISA rather than a pension, as long as people are making informed choices.”
Rutter also thinks that employers have to do better at communicating the benefits of pensions. “We need to talk about them in the same way as we do the LISA to make those benefits as concrete as a 25% government bonus towards your own home. We have to talk about what people’s goals are for when they stop working and how they are going to achieve that.”
Employers also need to think about how their pension contribution structures work. Those with relatively low matching contributions could see younger members opting out and losing the employer match.
Companies are saying ‘you can put your 5% into the pension, or you can put it into a LISA’
But firms with more generous structures could offer staff the best of both worlds. “Some of our clients offer 10% employer contributions if members pay in 5%,” says Barnett Waddingham’s Futcher. “A lot of those companies are saying ‘you can put your 5% into the pension, or you can put it into a LISA and we’ll continue to put our 10% into the pension’. They’re still hitting the auto-enrolment minimum.”
So what should we look out for this March? As usual there are rumours of further changes, and the LISA could yet prove to be a Trojan horse for the wholesale overhaul Osborne refrained from last year.
There is definitely an ISA agenda, and we should be very concerned about it
But Altmann thinks there will be no major changes in the next Budget. Longer term however, the fact that the Treasury has removed pensions from its Ways to Save infographic, which outlines people’s saving options, sends a pretty clear message.“There is definitely an ISA agenda, and we should be very concerned about it,” warns Altmann.
Futcher believes the logical sequence to move to an ISA-like system would be to start by restricting higher rate relief, a measure that would save the Treasury around £27bn a year in upfront relief.
“There is a lifetime allowance framework now that doesn’t let you buy a pension income that puts you in the higher rate bracket, so why would they continue to give higher rate tax relief on the way in?” he asks. “If they do that you effectively have a system where you’re getting 20% tax relief on the way in pay, paying 20% tax on the way out - it’s pretty much an ISA-style system.”
The lower they go the more money they save, but higher rate tax-payers still need an incentive
Or the government could look at a flat-rate system of tax relief somewhere between the 40% top rate and 20% basic rate. “That could save the government money and put its finances on a sounder footing,” says Darren Philp, director of policy and market engagement at B&CE. “Obviously the lower they go the more money they save, but higher rate tax-payers still need an incentive, so a rate of 25-30% could work.”
There is also the perennial rumour that the 25% tax free lump sum could in danger. “But getting rid of that would be political suicide,” says Philp. The way politics is going though, that doesn’t necessarily mean you should bet against it.