Pensions experts have warned the Chancellor’s new “Lifetime ISA” product – announced in the Budget on March 16 and set for launch in April 2017 – risks undermining existing pensions savings.
Instead of radically overhauling pensions taxation, UK Chancellor George Osborne chose to introduce a Lifetime ISA from April 2017 for people aged between 18 and 40, allowing them to save up to £4,000 a year with a “government bonus” of £1 for every £4 contributed.
The Lifetime ISA’s “government bonus” is designed to be broadly equivalent to the tax relief already granted to UK basic rate tax payers on their pension savings.
The government has set a maximum total lifetime contribution of £128,000 into the funds, for a maximum bonus of £32,000. This compares with a maximum lifetime tax-free allowance for pensions of £1 million.
Individuals can take the money out tax-free, and keep the “bonus”, if they use it for one of two purposes: buying a first home (up to a value of £450,000); or keeping it until the age of 60 and withdrawing it only after that. The government also said it would “consider” other uses for Lifetime ISA pots, and allow savers to borrow against their pots without penalty.
But as presently designed, if savers withdraw cash from the Lifetime ISAs for any reason other than housebuying before the age of 60, they would lose the bonus on “the fund”, and all interest paid on the bonus, and also pay a 5% charge.
The Government estimates the move, coupled with the raising of the existing limit on ISAs to £20,000 a year, also announced in the Budget, will cost the Exchequer £2 billion in foregone revenue over the next five years.
But pensions experts have warned the new product could hurt existing pension funds — and the young people who save into them — by encouraging them to opt out, and lose the far larger amounts typically paid in by their bosses as a result. Under UK auto enrolement rules employers will be required to pay a minimum of 3% of an employee’s gross salary into their pension by 2019.
Darren Philp, head of policy at the People’s Pension, one of the UK’s largest schemes by members, said there was nothing wrong with Lifetime ISAs “in principle” but he added: “I am not sure the government has thought this through in terms of the impact on Automatic Enrolment [into pension funds].
“Automatic Enrolment works on the principle of inertia. Opt-out rates have so far been low and that’s good. But young people have only got so much money to go around. And if they opt out of a pension in favour of the Lifetime ISA, they risk losing their employer contributions.”
Steve Webb, the former Liberal Democrat minister for pensions, who has now joined insurance company Royal London, said in a statement warning that a desire for a “shiny new initiative” risked undermining pensions progress for the young: “Just at the point that millions of under forties have started pension saving for the first time, the Chancellor has set up a rival product which risks causing mass confusion.
“Young savers who opt out of pensions in favour of a lifetime ISA lose the contribution from their employer and the chance to build a tax-free lump sum from a pension pot. How will they know which is right for them?”
Dean Mirfin, a technical director at Key Retirement, a consumer retirement-finance advisory firm, said: “At a time when auto-enrolment is engaging well with younger workers, could this pose a direct threat to the one thing the government has worked hard to create — a workforce focussed on a secure retirement?”
Others warned it could be a precursor to a more radical overhaul of the existing pensions tax system. Bob Scott, senior partner at pensions consultancy Lane Clark & Peacock, said: “Could the Lifetime ISA be a precursor to more wide-ranging reform once the dust has settled on the EU referendum?
“Perhaps leading to the scrapping of pensions tax relief in a year or two’s time, which we understood George Osborne favoured?”
He said it would “increase the appeal of longer-term saving to young people” as they would no longer have to choose between saving for a pension and getting on the property ladder.
And Parkin made the point that the Lifetime ISA changes could work out best for younger people with higher incomes: “For most people, they would still be best advised to use auto-enrolment and benefit from the matching employer contribution. These changes will be good for people who are lucky to have additional funds that they wish to save outside of auto-enrolment or who want to have a boost to their housing fund.”
Additional reporting by Elizabeth Pfeuti and Andrew Pearce