Lisa: How do the tax advantages of the Lifetime Isa compare to those of a regular Isa or pension? As its introduction draws nearer, Phil Warner takes a closer look.
The Lifetime Isa (Lisa) is viewed by some as a simpler version of a pension, but by others as more complicated Isa variant.
The truth is the rules governing the product are, in themselves, reasonably straightforward. But the complication comes when trying to compare the Lisa with either of the two more established saving vehicles.
When making such a comparison the tax treatment is key, although it is not the only consideration.
The Lisa will be available from 6 April 2017. It can only be opened by those who are over 18 and below 40 years of age. Subscriptions can then continue up to, but not including, age 50.
The maximum subscription is £4,000 a year, which must also fall within the general Isa allowance of £20,000 (2017/18). Subscriptions receive a 25 per cent government bonus. For example, a £4,000 subscription will receive a £1,000 bonus, making a total of £5,000.
Funds in a Lisa can be withdrawn free of income tax in the event of death, terminal illness, first-time property purchase (other conditions apply) or from age 60. Withdrawals at any other time will incur a 25 per cent withdrawal charge.
The most tax-efficient wrapper will largely depend on individual tax rates, both when paying in and when withdrawing.
The examples below assume monthly payments for 25 years into an Isa, Lisa or pension. These payments cost £4,000 each year, equivalent to £4,000 into an Isa, £5,000 into a Lisa, and a variable amount into a pension depending on taxpayer status. Investments are assumed to grow at 5 per cent a year net of charges, and inflation has been ignored.
Isa
£100,000 is paid in over 25 years. With 5 per cent growth this gives a fund of £196,000 that can be paid out free of income tax.
Lifetime Isa
£100,000 is paid in over 25 years, to which £25,000 of bonuses are added. This gives a fund of £245,000 that can be paid out free of income tax from age 60. Unsurprisingly, this is 25 per cent more than an Isa.
Pension
The amount paid in to a pension at a cost of £100,000 will depend on the tax rate when contributions are being paid. Twenty-five per cent of the fund will be paid out tax-free, with the remaining 75 per cent taxed as income. The net amount received will therefore depend on the tax rate being paid when the funds are withdrawn.
The amount received when compared with a Lisa is shown in Table 2. For example, an individual who is a basic-rate taxpayer when contributing and withdrawing will receive £37,000 less in a pension than in a Lisa.
For the significant proportion of the population who pay tax at a lower rate when they retire, a pension will be more tax efficient than a Lisa. For everyone else, a Lisa is more tax-efficient. Although the conclusion appears to be clear, there are other factors to be taken into account when deciding between wrappers and providers.
Are employer pension contributions available?
In the above example of an individual who is a higher-rate taxpayer, both when contributing and when withdrawing, an employer contribution of just £480 a year makes up for the superior tax efficiency of a Lisa compared to a pension.
This is broadly equivalent to an employee receiving a £1 employer contribution for every £10 gross employee contribution.
Will early access be required?
Funds within an Isa can be withdrawn at any point with no tax charge.
Funds within a Lisa withdrawn before age 60, and not due to first time house purchase, terminal illness or death, are subject to a 25 per cent withdrawal charge.
This was originally announced as being equivalent to losing the government bonus, any growth on the bonus plus a 5 per cent charge. This charge is actually equivalent to 6.25 per cent, as the following example shows.
A £245,000 fund taken early will incur a £61,250 withdrawal charge, resulting in a net withdrawal of £183,750. This withdrawal charge removes the bonus (£25,000), the growth on the bonus (£24,000), 6.25 per cent of the original subscription (£6,250), and 6.25 per cent of the growth on the original subscription (£6,000).
Funds within a pension cannot generally be accessed before the age of 55 (57 from 2028). Theoretically, a pension provider could offer early access through an unauthorised payment, but they are unlikely to do so, and if they did the payment would be subject to tax charges of up to 70 per cent (40 per cent unauthorised payment charge, 15 per cent scheme sanction charge and potentially a 15 per cent unauthorised payment surcharge).
Once an individual has reached the age of 55, pension monies should be immediately accessible, with 25 per cent tax-free and the remainder subject to income tax. This access is earlier than a charge-free withdrawal from a Lisa.
Is there sufficient investment choice and flexibility?
A Lisa could be used to save for a first-time house purchase or for retirement. Cash is likely to be most appropriate for house purchase within five years, with other investments being considered if 10 years plus is more realistic.
If the aim is to save for retirement then stockmarket investments are more likely to be appropriate.
A change of circumstances could mean that savings originally intended for house purchase are instead used for retirement and vice versa, which necessitates switching between investments.
Is age a factor?
Once an individual reaches their 40th birthday, it will be too late to open a Lifetime Isa. As an extreme example, those who reach 40 on 7 April 2017 will only be able to open a Lisa on 6 April 2017. If they do so, they will be able to subscribe for up to a further 10 years. But if they miss the deadline then the opportunity is gone.
Even if a Lisa is not immediately appropriate, then paying the minimum to start a Lisa will keep the opportunity open for the future.
What about bankruptcy?
The recent court of appeal judgement on Horton v Henry established that while monies are within a pension, they can’t usually be claimed by a trustee in bankruptcy.
Exceptions include the fact that an individual who could access their pension and chooses not to may be prevented from becoming bankrupt, excessive pension contributions could be reclaimed, and pension income could be subject to an income payments order.
In most cases a pension is therefore protected from bankruptcy until the age of 55. This bankruptcy protection does not apply to an Isa or Lisa.
But overall, is the Lifetime Isa a simple product in a complicated landscape? Pretty much.
• All of the data is based on draft legislation and guidance, as at 1 November 2016, and is subject to change.
Phil Warner is head of technical at Hargreaves Lansdown
