In yesterday’s Budget the Chancellor announced the launch of a new retirement savings vehicle for the under 40s – the Lifetime ISA. Whilst he stopped short of a radical reform of the system of pensions tax relief (as expected), this still marks a significant change to the retirement savings landscape. Crucially, the Chancellor left the door open to a more fundamental reform of pensions tax relief in the future whilst announcing further measures to help people make the most of their retirement savings.
What is the ‘Lifetime ISA’?
The Lifetime ISA will be a new retirement savings vehicle which will be available to individuals between age 18 and 40 from April 2017. Key features will include:
- Individuals will receive a £1 government bonus for every £4 that they save into a Lifetime ISA – equivalent to 20% basic rate tax relief.
- Annual contributions will be capped at £4,000 and will count towards a new total annual ISA limit of £20K.
- Savings can be used at any age towards payment of a deposit on a first home valued at no more than £450,000 (after a minimum of 12 months saving) or for any reason at or after age 60.
- Savings can also be withdrawn as a lump sum (tax-free) in the event of terminal illness at any age.
- Any other withdrawals before the age of 60 will mean forfeiting the government bonus on the part withdrawn (plus any interest or growth on that bonus), and will also attract a 5% charge – interestingly described as “small” in the budget paper.
- The government has said that it will consider whether funds in the Lifetime ISA plus the government bonus should be capable of being withdrawn early for other specific life events (in addition to buying a first home) and whether individuals should be allowed to borrow the funds in their Lifetime ISA without penalty, provided they are paid back in full before age 60.
- It appears as though an individual will be able to save into a Lifetime ISA as well as saving into a registered pension scheme, but there is no express confirmation on this point.
Other key points
The other key points to note from the Budget for pensions include:
- The government gave no formal response to its consultation on reforming the system of pensions tax relief, which is significant because it leaves the door open for more radical reforms in the future.
- The government will ensure the industry designs, funds and launches a pensions dashboard by 2019.
- There are a number of technical amendments to support the continued implementation of pension flexibilities, including permitting trivial commutation of defined contribution (DC) pensions already in payment where total pension savings would be under £30,000.
- There will be an increase in tax and NICs relief available for employer-arranged pension advice from £150 to £500 from April 2017.
- The government will also consult on introducing a Pensions Advice Allowance during summer 2016, to allow savers to withdraw £500 tax-free before the age of 55 from their DC pension to redeem against the cost of financial advice.
- The Money Advice Service, The Pensions Advisory Service and Pension Wise are to be restructured to produce a “slimmed-down” money guidance service, plus a new pensions guidance body which will exist “to make sure that consumers can get all their pensions questions answered in one place, at all stages of their lives”.
- Steps will be taken to increase the contributions made by employers to fund public sector pensions, by reducing the public service pension scheme discount rate.
- The government confirmed that it is considering limiting the range of benefits that attract income tax and NI advantages when provided through salary sacrifice schemes. However, it has indicated that pension contributions paid through salary sacrifice are safe, for now at least.
Once again, the Chancellor has continued his drive to reform the UK pensions system by introducing a new vehicle which younger savers can use to save for their retirement. Whilst this is designed to encourage younger people to save, it is experimental and its impact on the wider retirement savings landscape will be watched with interest.
For some individuals, such as the self-employed, those who can afford to pay into a Lifetime ISA as well as a pension, and first-time buyers, this new savings option may prove beneficial. However, there could also be drawbacks. In particular:
- There is a risk that the Lifetime ISA could encourage under-40s to opt out of auto-enrolment schemes. Whilst this might be good for tax receipts, it could undermine the success of auto-enrolment. It would also mean that individuals miss out both on their employer’s pension contribution and on the 25% tax-free cash lump sum (a highly beneficial element of the current pensions tax regime).
- It is unclear how funds in a Lifetime ISA will be invested and whether this will be suitable for long-term savings. Savers looking to put part of their Lifetime ISA savings towards a deposit may be inclined to invest in cash, which is unlikely to be a sound investment strategy for the long term.
- The regulation around pension schemes, such as the requirement to ensure value for money and good member outcomes, does not currently apply to ISAs, and it is likely that there will now be calls to ensure that savers are equally well protected in whichever long-term savings vehicle they choose. There is also a risk that pension scammers will target savings in Lifetime ISAs because of the ease of access. The 5% exit charge plus loss of government bonus is unlikely to be a sufficient deterrent for savers beguiled by promises of “guaranteed” high investment returns.
More broadly, concerns have already been voiced that the introduction of the Lifetime ISA – alongside the 2017 increase in the general ISA allowance - is just the first step towards the ultimate dismantling of the existing pensions regime. The Chancellor has not ruled out more fundamental reform of the system of pensions tax relief at a later date so the current uncertainty around the long-term future of the current system therefore seems set to continue. This risks undermining strategic pension planning by savers, employers, providers and trustees.