When the Chancellor published his Green Paper on ‘strengthening the incentive to save’ last summer, it seemed like we might be on the brink of a major reform to the tax treatment of pensions.
We geared up for the March Budget with speculation reaching fever pitch as to whether the ‘pensions Isa’ or the ‘flat-rate relief’ proposal was in the lead as the favoured option. Eventually, about 10 days before the Budget, the Treasury decided they had had enough of the speculation and, no doubt with one eye on the forthcoming EU referendum, made it clear that there would be no big changes to pensions in the March Budget because ‘the time was not right’.
But anyone thinking that we were in for a quiet Budget on the pension front would have had a bit of a shock when the Chancellor stood up. A profound announcement with big implications for retirement saving was to follow, and this one didn’t have the word ‘pension’ in its title at all.
On the face of it, the ‘Lifetime ISA’ is simply a new product which falls somewhere between a traditional short-term Isa with instant access and limited tax breaks, and a full-blown pension with generous tax breaks but tight restrictions on when the money can be withdrawn.
Under the Lifetime Isa you can get a government top-up of 25 pence in the pound on your net contributions (equivalent to basic-rate tax relief on your gross contributions). You have to open the account before you are 40, and can go on getting top-ups until the age of 50. You cannot access the account without penalty before the age of 60, except to put it towards the deposit on a house or in some limited exceptional circumstances such as being terminally ill.
One big issue is how younger workers are to decide whether or not this product is right for them.
The big fear is that young people, having relatively little disposable income for saving, may reject the workplace pension into which they have recently been automatically enrolled in favour of the seemingly more attractive Lifetime Isa. The consequence of this is likely to be that they will lose the valuable employer pension contribution that they would otherwise have received.
But it is not just the workplace pension which is an option for the younger worker. The existing Help to Buy:Isa will continue to run for several years. Under this scheme you can save up to £200 per month over a five-year period and receive a government top-up of 25 per cent - the same as with the Lifetime Isa. Unlike with the ‘Lifetime Isa’ there is no ‘exit penalty’ for withdrawing your money early, although you do lose the government top-up.
In addition, the government has just launched a ‘help to save’ scheme specifically for lower-paid workers receiving working tax credits or the new universal credit. Under this scheme, savers can put in up to £50 per month and receive a 50 per cent top-up if they continue to do so for two years. If they continue to save for another two years, they can get a further 50 per cent top-up, giving a maximum potential top-up of £1,200. It seems likely that this would be the best deal of the various short-term saving schemes on offer, though awareness of such schemes tends to be low and take-up is often very poor.
Apart from the complexity of choosing between this raft of shorter-term and longer-term savings options, the big concern is that the special status of pension saving as previously understood could gradually disappear.
Consider, for example, the case of a young worker with his or her heart set on buying a home. They are automatically enrolled into a workplace pension at the age of 22 but they decide that the 5 per cent of gross pay that they would have to contribute is too much when they want to put every penny into saving for a deposit. So they opt out and instead put some money into a Lifetime Isa. Unlike with a pension, the monthly saving is no longer automatic but they set up a direct debit and start to build up a worthwhile sum. A few years later they form a partnership – naturally with someone else who has a Lifetime Isa – and together the couple starts to build a decent capital sum with government top-up.
Around this point, the worker is automatically re-enrolled but they opt out again, single-mindedly focusing on money for the deposit. Money is tight and the couple are saving what they can, but another three years goes by and each is re-enrolled for a second time, and again they opt out because pensions are not for them. A few more years go by and the couple now have enough for a deposit, perhaps assisted by the ‘help-to-buy equity loan’ scheme. They take all of their money out of the Isa and put it into buying a house. They are in their early 30s and their retirement savings stand at zero.
The interesting question is what happens next?
The couple are still relatively young, but money is tight. They have borrowed as much as they can afford and there is not much spare cash after mortgage repayments, especially with their first child on the way. They have got into the habit of monthly saving into an Isa and they can see that they get a government top-up, but they decide they cannot both afford to save, so one of them cancels the direct debit. Automatic re-enrolment comes round again, but by now the workplace pension is something they have rejected repeatedly and it does not seem like a priority.
In one sense, this is not a terrible outcome. The couple have got the home of their dreams and at least one of them is saving on a regular basis and getting the equivalent of basic-rate tax relief on their savings. But since they were both 22, they have been missing out on a contribution from their employer into their long-term savings. If they are in their early 30s they will have missed out between them on perhaps £10,000 or so of employer contribution that they will never get back. And if they continue to choose the Lifetime Isa over the workplace pension then the amount they miss out on will grow each year. Worse still, beyond 50, they do not even get the government top-up, so the Lifetime Isa starts to look like a highly unsuitable vehicle for retirement saving.
This is, of course, speculation. But you can be sure that the Government will be promoting this scheme hard, while the budget for advertising workplace pensions is unlikely to be a priority. Over time, the whole culture of workplace pensions could be undermined.
It would be ironic if an initiative branded as promoting ‘lifetime savings’ was instead to undermine the very thing that it was designed to support.
Steve Webb is director of policy and external communications at Royal London, and former pensions minister
Key points
On the face of it, the ‘Lifetime ISA’ is simply a new product which falls somewhere between a traditional short-term Isa and a full-blown pension.
The big fear is that young people, having relatively little disposable income for saving, may reject the workplace pension.
It would be ironic if an initiative branded as promoting ‘lifetime savings’ was instead to undermine the very thing that it was designed to support.
