On 16 November 2016, the FCA published consultation paper CP16/32, which sets out proposed changes to the FCA’s Handbook to reflect the expected introduction of the Lifetime ISA (LISA) from April 2017. The LISA allows individuals aged between 18 and 40 to save or invest flexibly to either provide for a deposit for a first home or save for retirement. Consulation paper CP16/32 can be downloaded from the FCA's website.
What is the LISA?
The LISA is a new type of ISA designed to encourage saving by individuals under the age of 40.
Investors who open a LISA will be able to:
- pay in up to £4,000 each tax year up to age of 50 (the Government will add a 25% bonus to these contributions).
- use accumulated funds, including the Government bonus, to help buy a first home worth up to £450,000 at any time from 12 months after first saving into the account; and
- withdraw the accumulated funds at any time to purchase a first home or in case of terminal illness, or after the age of 60. Investors will lose 25% of any money they withdraw before age 60 for any other purpose (called the early withdrawal charge).
Investors will be able to contribute to one LISA each tax year, without impacting the ISA subscription limit available for the other ISA types, and invest using the LISA wrapper into investments which currently qualify for the cash and stocks and shares ISAs (but not innovative finance ISAs).
The FCA’s approach
Generally, FCA regulation of ISA wrappers is predominantly based on the underlying investments, rather than the wrapper itself. However, as the LISA wrapper encompasses the features of both a short-to-medium-term deposit savings product with a long-term retail investment product, the FCA has identified a need to ensure consumers are protected as regards the LISA wrapper itself.
In particular, the FCA has identified five categories of risk:
- Complexity - in that investors may not understand the purpose, features and restrictions of a LISA, as well as the differences between the features of a pension and a LISA.
- Contributions - investors may lose out on an employer’s pension contribution if they opt out of a workplace pension in favour of saving into an LISA, and if they fail to use other savings options after reaching 50, when LISA contributions are no longer possible.
- Investments - investors may invest in an inappropriate asset mix if they start by investing for a house and then later save for retirement without updating their investment strategies.
- Access - investors may not understand the early withdrawal charge, the impact of the possible absence of protection under the Financial Services Compensation Scheme (FSCS) and client money rules, and that, while they can withdraw from a LISA when they reach 60, they can access funds held in a personal pension at 58.
- Tax - investors may not be able to compare the Government bonus with tax relief on pensions, or understand the difference in how the proceeds of a LISA and a pension are taxed.
The FCA proposes to address these risks through amended or further requirements or guidance relating to communications, preparation and provision of product information, cancellation and safeguarding of client money.
Firms will need to provide investors with information about how a LISA works, for example in terms of eligibility, Government bonus and early withdrawal charge. The FCA proposes that investors receive specific risk warnings in respect of the early withdrawal charge, and the fact they could potentially lose an employer contribution to a workplace pension for which they may be eligible, were they to choose to open a LISA instead.
Preparing and providing product information
The FCA proposes that investors, before opening a LISA, receive disclosure regarding how it works, explaining:
- the key features and eligibility requirements of a LISA wrapper;
- the early withdrawal charge, for example in terms of the level of the charge, when it would apply, and a warning that in incurring the charge an investor may get back less than they have put in;
- that if an individual opts out of a workplace pension for which they are eligible in favour of saving in a LISA, they may lose out on an employer contribution to their retirement saving; and
- the process for transferring a LISA to another provider.
Firms will also have to provide investors with an explanation of the different savings objectives for which a LISA can be used, the types of investments that can be held in the LISA offered by the firm, and an indication, in a prescribed form, of what they might get back from a LISA at age 60.
As LISAs have greater restrictions on access than other ISA types, the FCA sees it as even more important that investors have the ability to reconsider their investment before they are locked in. As such, the FCA proposes allowing investors a 30 days cancellation period when opening a LISA, except where the LISA is opened at a distance when a 14 day cancellation right will apply, as required by in the distance marketing directive. The FCA proposes allowing firms, in the alternative, to provide a 14 day pre-contract withdrawal right rather than the 30-day cancellation period. However, other exemptions to the cancellation right requirements which currently exist for stocks and shares ISAs will not be available for LISAs.
Safeguarding client money
Holding money within a LISA creates complexity from the perspective of the client money rules, in that money invested in a stocks and shares component would fall within the scope of the rules, whereas cash held on deposit would not. To resolve this, the FCA proposes that all monies (both that in held the stocks and shares component and the cash component) received or held by an investment firm for, or on behalf of, a client in the course of or in connection with a LISA should be held by the firm in accordance with the client money rules. This will not prevent credit institutions currently using the banking exemption in the client money rules continuing to do so. In addition, FSCS protection will apply in the same way as for cash ISAs and stocks and shares ISAs currently.
Comment and next steps
LISAs could be potentially very attractive for investors, acting as an additional tax efficient savings mechanism in addition to holding a pension or a Help to Buy ISA. For LISA providers, barriers to providing LISAs are likely to be either operational or legal.
CP16/32 closes to responses on 25 January 2017 and the FCA intends to publish a policy statement containing final rules and guidance in March 2017. ISA managers will be able to offer the LISA from April 2017, subject to HM Revenue and Customs approval.