Lifetime ISA – the ISA Pension for the Facebook generation?
The shock announcement of the Budget was undoubtedly the Lifetime ISA – pitched at the “next generation”. Search the internet and you will find various descriptions of that generation - ranging from those struggling to get on the housing ladder to a group more interested in Facebook and the next iPhone than saving for retirement.
It is no secret that the ISA wrapper is hugely popular, and viewed as simpler that its pension counterpart.
This is largely down to the fact that people know that money held in an ISA is free of tax on income or gains, and can be accessed free of tax at any time.
The Lifetime ISA is the Chancellor’s Facebook friend request to this generation, whether it is used to purchase their first home, or boost retirement savings.
Details are still scarce at this stage, but here is what we know so far in advance of the legislation due in the autumn:
Lifetime ISAs can be opened from 6 April 2017 and will be available to those aged between 18 and 40.
Like other ISAs, a saver will be able to have more than one Lifetime ISA, but they will only be able to pay into one of this type in each tax year.
There is provision for those who have already started Help to Buy ISAs to roll these into Lifetime ISAs. Help to Buy ISAs will stop accepting new contributions in 2029.
The term ‘contribution’ is used 25 times throughout the Lifetime ISA technical note. This is particularly interesting as this is more typically associated with payments into a pension. Money paid into ISA accounts is defined as a subscription. The ISA looks to have earned its first pension status update.
Contributions made to a Lifetime ISA will count to the increased ISA allowance of £20,000 for 2017/18. This allowance applies across all available ISAs (cash, stocks and shares and Innovative Finance) in any tax year.
Savers eligible to open Lifetime ISAs will be able to contribute £4,000 per annum, topped up by a government bonus of up to £1,000 at the end of each tax year. The bonus will be available for contribution made until age 50.
Assuming these limits are unchanged, this equates to a maximum potential bonus of £32,000 on contributions of £128,000, before any interest or growth.
The year-end bonus itself will be claimed by the ISA Manager from HMRC. If the saver is looking to exit the Lifetime ISA to fund a house purchase, bonuses accrued at the time of purchase can be received earlier, without having to wait until the end of the tax year.
Savers will potentially be able to contribute more than £4,000 each tax year, or past age 50, albeit without the addition of further bonuses.
The Lifetime ISA proposals do not include any provision for employers to make a tax relievable contribution in the same way as pensions. However, current ISA regulations do allow ISA subscriptions to be made via an employer, provided they make the appropriate PAYE and NI deductions.
Investors looking to purchase their first home or those who have reach age 60 will enjoy tax free withdrawal of funds from the Lifetime ISA.
Savers can withdraw all of their Lifetime ISA (including the bonus) before 60 to purchase their first home, provided it is located in the UK and worth up to £450,000.
The withdrawal must be for a deposit on a property for the first time buyer to live in as their only residence, and not buy-to-let.
Withdrawals from age 60 can be made for any purpose, and they will be free of tax. Contrast this with pensions where only 25% of the pot can be taken tax free and the Lifetime ISA certainly looks attractive as a retirement planning tool.
Like pensions, savers will be able to withdraw all funds (including the bonus) free of tax as a lump sum if they’re terminally ill. The ill health definition will be the same as for pensions – another tag for our friend the pension.
The current proposal is that any full or partial withdrawals will be allowable, but if they do not fit into the categories above, the government bonus will be lost, and a further 5% charge applied for the pleasure.
I think people will understand the loss of the bonus, but a 5% withdrawal is not a ‘small charge’ as described in the government documentation.
The Facebook troll – a 5% charge
The government wants people to save for the long term, but this troll looks a lot like the early exit fees on pensions that are currently in the Government’s sights. The FCA is soon to legislate on the definition of an excessive pension exit fees so it will be interesting to see how the 5% proposal for Lifetime ISAs compares with these rules.
As the details of the charge are yet to be finalised, one question ISA managers will be asking is how to identify the value of the government’s share and any income and growth attributable to that?
For example, a saver makes the full contribution of £4,000 on 6 April 2017 and the investment grows to £6,000 by the time the ISA manager claims the government top up of £1,000 at the end of the tax year giving a total ISA fund of £7,000. If the investor looks to make a withdrawal in a future year but the value of the fund then falls to £3,000 just how is the government top up that needs to deducted calculated? Will it be the original £1,000 with no growth - leaving just £2,000 attributable to the contribution itself - or will it be a straight 20% of the £3,000 value with no growth deducted?
Borrowing and beyond
The government tells us it wants to explore the possibility of savers borrowing funds held in the Lifetime ISA without incurring a charge in certain circumstances.
One interesting proposal is to allow savers to borrow up to 50% of funds from the Lifetime ISA without incurring a charge if the funds are fully repaid.
So how will all this be paid for? The cost of the rise in the general ISA allowance to £20,000 plus the Lifetime ISA top up will cost around £330 million for 2018/19. This is low when compared to the estimated cost of up to £1.5 billion of high earners scrambling to make use of contribution allowances before the budget fearing that Mr Osborne was going to announce a flat rate or pension ISAs for all.
Impact on pensions
There is no doubt that the Lifetime ISA will be viewed as the Chancellor dipping his toes into pension tax relief reform. Although we didn’t see the introduction of a Pensions ISA, the finer detail certainly indicates we now have an ‘ISA pension’.
Hidden away in the Budget documents was the tax relief consultation response. The fact it simply summarises the responses received by the government, and not their own proposals is a clear sign changes are not off the table.
Concerns have already been raised about an increase in auto-enrolment opt out rates. This would be disappointing given the time, effort and resource dedicated to auto-enrolment implementation over recent years. Members will be missing out on valuable employer pension contributions.
Higher and additional rate taxpayers may not view the bonus (equivalent to 20% relief at source on pensions) as high enough to warrant diverting any pension savings to a Lifetime ISA. Although not the target audience of the proposals, higher-earing young clients and their advisers may still look at the Lifetime ISA where access to funds is not required, particularly with the exemption from the lifetime and annual allowance that apply to pensions.
Is the retirement age of the Lifetime ISA the clearest sign yet we are looking at rises in the minimum retirement age for all pensions? Plans were for the minimum retirement age to track 10 years below state pension age but this was left out of recent legislation. For the time being, this is an obvious disadvantage of the Lifetime Isa which can only be accessed tax free from age 60 compared to the current age 55 for pensions.
Another big draw of pensions in their current form is the ability to pass down unused funds over the generations, free of inheritance tax.
The lifetime ISA will be chargeable to IHT in the same way as other ISAs – although spouses and civil partners will be able to inherit the value of the deceased’s fund as an additional subscription allowance.
The lifetime ISA will also be included an estate for bankruptcy purposes and affect means-tested benefit entitlement, in contrast to money held in a pension wrapper at the time of writing. The borrowing proposals may help those who find themselves in short term financial difficulty but if you want to access the whole account, you will face a bonus loss and 5% charge before age 60.
In conclusion, we have another new type of ISA designed primarily for the Facebook generation.
We don’t know what updates are planned to the profile page of pensions and tax relief, but one thing for sure about our relationship status with ISAs is that on budget day it changed from “In a relationship” to “It’s complicated”.