One of the biggest changes in the Isa regime ever is about to go live.
The “Lifetime Isa” launches on 6 April this year. It is designed to be used for two big financial life events – buying your first house, and retiring.
So how does it work, and is it any good?
How the Lifetime Isa works
Here’s how the Lifetime Isa works. First off, you have to be under 40 to open one (and 18 or over). So if you’re over the age limit (like me), tough. But frankly, I wouldn’t be too disappointed – it’s just another complication you don’t need to worry about.
OK, so for those of you who are able to open one (or who might consider funding one for offspring), how does it work?
The first point to note is that it’s not much like a standard Isa. You can pay in up to £4,000 a year. That money can go into stocks and shares, or cash. The government will top that amount up by 25% (so up to £1,000), until you turn 50.
So you’re getting basic-rate tax relief on your contributions. From that point of view, it’s more like a pension.
Again, unlike a standard Isa, there are tight restrictions on what you can use the money for.
If you are a first-time buyer, you can withdraw the money to put a deposit on a house with a value of up to £450,000 (as long as you’ve held the Lifetime Isa for at least 12 months). Otherwise, you can’t take the money out until you turn 60.
If you breach these rules, then you’ll be charged a 25% penalty on any money withdrawn. So your bonus gets taken away, plus a bit more on top.
So, in short, the Lifetime Isa is designed to encourage you to save for either your first property or retirement. Part of the idea seems to be that you tempt people in by contributing to their property fund, and then, once they’ve bought their first house, they’ve attained the savings habit, so they stick with it.
Should you use a Lifetime Isa or a pension?
If you’re saving for a deposit on a house, it’s hard to argue with a Lifetime Isa. The government is giving you a 25% top-up to your eventual deposit. Why wouldn’t you take it?
On a society-wide level, of course, it’s nuts. All you’re doing is using taxpayers’ money to drive up house prices and subsidise the profits of housebuilders. But that’s the joys of living in a property-obsessed democracy for you.
You can use the Help-to-Buy Isa instead – we’ll talk more about how the two interact in the MoneyWeek Isa supplement (subscribe now to reserve your copy) – but the differences between them are a matter of admin and making sure you get your timings right, rather than any big difference in benefits.
So that’s pretty straightforward.
But when it comes to the idea of using a Lifetime Isa as a pension substitute – that’s not so simple at all.
The main point for most people is this: if you have a workplace pension, then your employer will be contributing to it. You can’t do this with a Lifetime Isa (yet). So if you ditch a pension for the Lifetime Isa, then you immediately lose those extra contributions – and that’s not worth it.
Beyond that, the tax implications are different. With a Lifetime Isa, you get the equivalent of basic-rate tax relief when you put your money in. With a pension, you get either basic-rate relief, or you get higher-rate relief if you’re a higher-rate taxpayer.
With a Lifetime Isa, when the money comes out at the other end, it’s not taxed at all. With a pension, only 25% of the money at the other end is tax-free.
What this means is that if you’re a basic-rate taxpayer all your life, the Lifetime Isa saves you more tax. And if you’re a higher-rate taxpayer all your life, a Lifetime Isa also saves you more. But if you’re a higher-rate taxpayer while you work, but a basic rate taxpayer when you retire, the pension is more tax-efficient.
Cutting through to the practicalities: for most people who earn salaries from an employer, a pension will still be a better bet simply because of the employer contribution.
But if you’re self-employed or otherwise not party to an employer’s pension scheme – or you’ve already got a defined benefit pension scheme – then the Lifetime Isa becomes more interesting as an option.
Again, we’ll be looking at the gritty details in the Isa supplement.
The biggest risk of Lifetime Isas
The biggest risk here – as with any government-backed savings product that ties your money up for the long term – is politics.
Any time a government sees a big pot of savings that can’t be accessed, it tries to think of ways to get its hands on it.
People with pensions already know from bitter experience that the rules governing them change – for better or for worse – every single year. Put bluntly, it’s a pain in the neck.
The Lifetime Isa is a young product. If you plan to use it as an alternative to a pension, then even if you’re 39 today, you are committing to locking your money up for just over 20 years before you can access it without penalty.
Between now and 2037, you’re going to see a minimum of four general elections (one every five years from 2020), and Lord only knows how many changes of chancellor. Who knows what wild and wacky ideas they’ll come up with during that time?
Of course, the same risk applies (in many ways even more so) to pensions. This has improved since George Osborne’s reforms made pensions easily accessible at 55, with the option to do what you want with them. But that could be reversed or tinkered with at any point.
In all, it’s another reason to think carefully before locking your money up in any long-term savings product. The major benefit of the bog-standard Isa is that it’s extremely flexible. It’s worth considering how you value that flexibility against the potential benefits of going with a Lifetime Isa or a pension.
We’ll be looking at all of these questions – and giving you some ideas of what to put into your investment vehicle of choice – in the MoneyWeek Isa special, out next week. Subscribe now, if you haven’t already – we’ve also got a very special free gift lined up for the first 250 readers who sign up.