Lifetime ISA

  • In April 2017 the Lifetime Individual Savings Account (LISA) will launch.
  • The product is aimed at first-time homebuyers but can also be used as a pension.
  • You can contribute up to £4,000 a year and the government will add 25% to your pot each year.
  • Cash and investment LISAs available.
  • If you have a Help-To-Buy you can transfer it to a LISA.

Financial planners will be penciling the 4th of April 2017 into their calendars. The LISA provides additional flexibility for clients looking to save for a new home or for retirement, by offering a 25% bonus on savings made into the account each year.

The LISA has a number of terms:

  1. You have to be under-40 and over-18 when it is launched.
  2. The maximum you can pay into the LISA each year is £4,000.
  3. The bonus is paid until you hit 50 years old (therefore max. bonus of £32,000).
  4. Interest from bonds or capital gains from investments will also be paid on the bonus amount.
  5. Withdrawals are allowed before the age of 60, but you lose your bonus payments and the cost is 5% on the amount withdrawn.
  6. You keep your bonus and don’t pay a charge if the withdrawal is for buying your first home.

A boon to this investment is the rise in the ISA limit from £15,240 this year to £20,000 next year meaning, even with a LISA, your ISA allowance is a hefty £16,000. With the ability to invest in cash (i.e. interest rate paying accounts) and investments (stocks and shares), and the guarantee of a 25% bonus on the amount you save each year, the LISA is a good addition to a portfolio of savings. Similar to an ISA you won’t pay tax on dividend payments, capital gains or interest payments.

First home buyers

The LISA’s ability to aid first time home buyers is a major selling point. Couples looking to purchase their first home can contribute to a LISA each (£8,000 a year + £2,000 bonus), provided neither of them have owned property before or the value of their first home does not exceed £450,000. If the couple end up not buying a property, or buy a house over £450,000, they can opt to use their LISA as a pension pot, and have the freedom to withdraw from it whenever they want (although at the costs above). Therefore the LISA offers a great deal of flexibility.

The alternative for first home buyers is the Help-To-Buy scheme, however in contrast it will only pay the bonus amount on properties worth £250,000 outside London (£450,000 inside), there’s no interest on the bonus as it is paid when the home is purchased, and the maximum bonus paid is £3,000 (vs. £32,000 LISA). However unlike the LISA, the Help-To-Buy scheme can be paid into from the age of 16 and does not have an age limit.

Wealthy parents and grandparents will likely take advantage of the LISA to help support their offspring. Parents interested in helping their children save for their first home can start paying into a Help-To-Buy at 16 and then transfer it into a LISA at 18. Furthermore grandparents have a yearly allowance of £3,000 per person that is inheritance tax free, this allows them to contribute into a grandchild’s LISA; encouraging intergenerational transfers free from the taxman and receiving an extra 25% from the government.

Pensioners

If you decide not to use it for your first home, the LISA can also be used as a pension. An individual contributing the maximum of £4,000 each year, with an average growth rate of 5% plus the 25% government bonus, would see the pension pot reach £709,966 by 60 (assuming they pay in the maximum amount each year from 18). That’s an annual retirement income of approx. £35,000.

On top of this the LISA has additional benefits over a traditional workplace pension: it can be used to buy your first home, you are able to withdraw the funds prior to maturity (although at risk of losing the bonus and paying 5%), and it is tax free on withdrawal; whereas although a workplace pension offers a 25% lump sum tax free, the rest is taxable. In this case the LISA, as it is funded by post-tax income today, is a clever tactic by the Chancellor to take tax revenues from the future.

However the workplace pension will likely remain as the go-to savings account for retirement. Annual contributions are maxed at £40,000 a year, significantly higher than the LISA’s limit of £4,000, and employers contribute to a percentage of the pension for you also (i.e. you contribute 8% of your income and the employer tops it up with an additional 3%). Higher rate tax payers receive a 40% tax relief, such that you pay £100 into your pension (incl. employer contribution) and receive an additional £40. In the case of LISA there is also the risk of the Government changing the rules in the 42 years, this could be a change in the bonus from 25 per cent to a lower amount. Lastly, you can start withdrawing from a workplace pension at 55 years old, rather than 60 years old with the LISA. As a result the workplace pension comes out as more tax efficient and can also be significantly larger – with employer contributions and a higher annual allowance.

Why introduce the LISA?

As briefly mentioned LISA has a tax advantage for the Chancellor, who is collecting tax today in lieu of tomorrow. The LISA is paid for with post-tax income, therefore this puts the Government on the right side of the time value of money, allowing them to invest and pay off interest today.

LISA also provides a great incentive for individuals to save for a new home, which may help boost housing demand and therefore house prices, which is good for the economy in aiding the UK’s manufacturing industry.

Furthermore the movement from defined benefits to defined contribution schemes means that pensions are a less ‘sure thing’ for the millennials than they were for the baby boomers. In a defined benefits scheme you are paid a pension based off the number of years you work at a company and your final salary, however the new defined contributions scheme means your pension is based on the amount your investments make over the period of your career. You have to hope the market goes your way so you can afford a decent pension at retirement. By providing alternatives, such as increasing the ISA limit to £20,000 and offering this LISA, the government may be helping millennials ensure they have enough at retirement, thus reducing the burden on future state finances.

Summary

The LISA provides first time home buyers with a great tool to save towards their new home. Rather than putting money away in a 2-4% savings account, you can receive 25% from the government each year – and also have the ability to double up with your partner. If the house you buy ends up exceeding £450,000, or you end up inheriting a home, your LISAs can then become pension pots, to be withdrawn at the age of 60. With the ability to place the money in cash or investments, LISA acts as a normal ISA and is therefore quite flexible. However with larger annual allowances, tax relief, and employer contributions, the workplace pension is likely to remain the priority for pension savers. The LISA’s main benefits include saving for a new home, or acting as an additional savings account for the wealthy. The LISA also has the additional benefit of providing parents and grandparents with an option to help contribute to their offspring’s future.

-Ed

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