ISAs  

The pension-Lisa balancing act

The pension-Lisa balancing act

Whatever challenges Millennials face, one thing is certain: they are not short of ways to save. Alongside Isas, Sipps and auto-enrolment in the workplace, there is a new incentivised savings plan on the horizon for the under‑40s – the Lifetime Isa, or Lisa.

Due to be launched in April 2017, the Lisa is the government’s latest plan to help younger people get on the housing ladder. Savers need to be aged 18 to 40 to open one, and can receive a cash bonus of up to £1,000 a year for every £4,000 saved up to the age of 50 – giving a maximum lifetime bonus of £32,000 on savings of £128,000.

Withdrawals can only be used towards a home purchase before the age of 60 (except in cases of serious illness) or penalties apply. After 60, the accrued cash and bonuses can be withdrawn tax-free and used for any purpose the saver wishes, potentially providing a complement to other pension savings. 

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Combining a 20 per cent bonus on the front end and tax-free returns on the back end, the Lisa is being touted as an attractive alternative to a defined contribution (DC) or personal pension, where only 25 per cent of the final payout is guaranteed to be tax-free.

For younger clients who cannot afford to put money into both (and assuming they do not have access to a final-salary pension scheme or other pensions with generous guarantees), which is the better savings option: a pension or a Lisa?

Here are some factors to think about when evaluating the worth of these schemes for your clients.

Is home ownership a priority?

A Lisa will enable a saver to build up a deposit towards a first home worth up to £450,000. As every individual has their own Lisa allowance, it enables two first-time buyers to pool their resources and receive up to £2,000 a year in bonuses for every £8,000 they save.

This makes the Lisa very attractive to couples as a means of accelerating their move on to the housing ladder. Plus, of course, parents and grandparents can chip in, bearing in mind that gifts of up to £3,000 a year can be made free of inheritance tax.

What is their income tax rate?

The £1 for £4 bonus on a Lisa means the upfront incentive is identical to the 20 per cent tax relief available on a pension for a basic-rate or non-taxpayer. When a Lisa is being used to save for retirement, rather than to purchase a house, the overall tax attractions of Lisas versus pensions will also depend on an individual’s rate of tax in retirement. 

If an individual pays 40 per cent tax while working, but 20 per cent or 0 per cent tax in retirement, a pension will, under the current tax treatment, still be the more attractive option. However, in a scenario where they continue to pay 40 per cent tax in retirement, the completely tax-free returns on a Lisa start to appeal.

Do they get employer pension contributions?

Additional contributions from an employer are one of the biggest incentives to put money into a pension. In many cases, these are matched one-for-one against the employee’s own contributions (up to a certain limit) on top of whatever tax relief the government gives. Under these circumstances, the only possible situation where a Lisa wins out is when very low qualifying earnings severely limit how much an employee can contribute to a pension. Even then, it is probably still worth maximising any employer contributions that are available.