The Lifetime ISA vs Occupational Pensions and SIPPs

The last Chancellor of The Exchequer George Osborne (GO) would probably like to be remembered for his innovation and encouragement of disruptive alternatives to banks such as P2P/Crowdfunding and the Innovative Finance ISA.

However, I am looking at the Lifetime ISA (known as LISA) which launches in the next financial year from 6th April 2017.

Its key objective is to help savers buy their first home with a secondary objective to assist with retirement funding to age 60 after which the LISA can be drawn down tax free.

In practice GO’s innovative ideas are proving to be more difficult to implement; firstly Chancellor Phillip Hammond is now in command of HM Treasury and in stark contrast to the more flamboyant GO, ‘Spreadsheet Phil’ is a details man, and much more cautious.

Watchdog, the Financial Conduct Authority (FCA), has only just published the rules around operating a LISA as it worried about product warnings to ensure that consumers are not misled about exit penalties.

LISA is currently set up to offer those between 18 and 40 the opportunity to save for a first home or to supplement their retirement savings.

For investments of up to £4,000 per annum the Government (HMRC) will contribute a 25% ‘bonus’ to some degree in a similar fashion to the tax relief on Occupational Pensions and SIPPs. To ape continuing adverts, it is simples – every £4,000 generates £1,000 government subsidy.

‘the opportunity to save for a first home or to supplement their retirement savings’

The worry is that people may opt out of auto-enrolment schemes or other occupational and personal pension schemes, including SIPPs, in favour of LISA thus potentially foregoing higher tax reliefs on personal contributions.

However, Spreadsheet Phil has sharply cut the annual allowance for contributions to pension schemes to a miserly £4,000 per annum to combat recycling under another GO innovation to create a more flexible retirement benefits system and disrupt the annuity market.

This low threshold can apply when the annual allowance of £40,000 is tapered for higher earners down to £10,000, but then further restricted if investors have taken advantage of pension freedoms to a floor of £4,000.

FCA wants to see specific warnings about opting out of pension provision and is worried that the exit penalties on a LISA may not be fully understood by consumers; it is therefore pressuring the very few providers who have announced plans to launch LISA from 6th April – others are waiting to see how the market develops and to develop system capabilities for collecting the HMRC 25% handouts.

It is therefore no surprise that platforms with SIPPs are amongst the first to declare their interest, because they have systems (albeit needing adaption) to collect the bonus from HMRC.

ISA providers such as fund managers will not have this expertise which in part explains the delay in coming to the LISA table; it is much easier for a SIPP Provider to shut off functionality than for GIA or ISA providers to step up.

Solicitors will warrant that a property purchase is indeed the first by the purchaser thereby allowing investors to draw down on LISA. This will be a relief to providers worrying about how to certify a first purchase, with solicitors subject to their own regulator, the SRA.

LISA has advantages over the 500,000 or so Help to Buy ISAs sold to date particularly for first time buyers for properties of up to £450,000; the Help to Buy ISA only pays out a bonus on completion of the purchase – too late (unless there is bridging finance – another cost) to assist with the purchase.

It is expected that many Buy to Let ISA Investors will look to transfer to LISA so that they can use their investments and HMRC handouts at the time of exchange rather than completion – a much greater incentive than the Help to Buy ISA.

Additionally, usually being a couple, LISA investors can each open an account and independently receive the 25% on their savings – a great advantage over the Help to Buy ISA.

You can hold both a Help to Buy ISA and a LISA – in fact it may be beneficial to open a LISA as you still have that transfer option and you need to trigger the one year holding for the LISA; even £1 to the LISA would do to get the one year bar off to a good start.

So what of the FCA concerns? Well unless a LISA is cashed in to support a first time property purchase or to support retirement savings at 60, many will think that the 25% penalty just offsets the HMRC tax handouts up to £1,000 per annum for those contributing £4,000.

The only exemption is a serious ill heath exemption; very new to ISA providers but one that pension providers are fully familiar with – another complexity for ISA claims teams.

However, on death of the holder the recipient’s spouse could have their annual ISA allowance increased by the amount of the LISA including HMRC handouts. Not as wide as pension eligible beneficiaries but a first cut in a conservative ideology of handing on wealth; once transferred to another account the ISA will be subject to Inheritance Tax.

An FCA concern is that savers may not understand that the 25% tax on exit applies to the whole value of LISA if they do not qualify for a first time purchase, retirement at 60, or earlier death.

Providers such as A.J. Bell have stated that they will delay any launch of LISA until they have finalised the risk warnings to customers.

Investors cashing in early before age 60 will also have to address an additional 5% tax on the accumulated fund.

I mentioned system complexities earlier in the article. HMRC is looking for real time information (RTI) in relation to LISA subscriptions. This is a huge systems upgrade from the usually manual Magnetic Media Returns; another complexity for providers.

On the plus side the Government has agreed that there will be no exit penalties in the first Year of LISA; I have not been able to find a definitive response to transfers into LISA.

‘is the LISA a stalking horse for pension tax relief reform?’

A bonus is that HMRC will pay the full 25% up to £4,000 during the financial year 2017/18 no matter when the amounts up to £4,000 are paid. In 2018 it is looking to a monthly addition of 25% to contributions based on each subscription date up to that maximum of £4,000 – another test for providers.

This is great news for savers as it will allow savers to benefit from the incentive during the year; it is a savings maxim to re-invest dividends and the same for HMRC bonuses.

Also there is good news that the LISA counts for the new £20,000 limit per person on ISA subscriptions.

So, what sort of investments can a LISA invest in?

Cash with a licensed deposit taker such as a bank or building society; stocks and shares including eligible funds – most pundits would say the best option for longer term investing as you are subject to market rises and falls.

So is the LISA a stalking horse for pension tax relief reform? Not currently unless Spreadsheet Phil has an injection of GO; the LISA is likely to be slow burn.

There is no doubt that a number of organisations such as the champions of ISA’s – The Tax Incentivised Savings Association (TISA)– are committed to pension tax reform and the promotion of ISAs over pensions, which is indeed good news for a government looking to save money on retirement tax relief.

However, George had a go at a stalking horse for pension tax relief reform and even he retreated.

We play with tax reliefs on pensions at our peril. I don’t disagree that a more balanced distribution is more equitable across the whole population, but high earners are well disgruntled.

They pay their taxes yet may be pegged back on reliefs. That is not equitable either. The arguments for post taxed savings and pre-taxed savings will continue. That is for sure!

<sub>Francis is an expert in pensions and savings.

Francis created the first self-invested personal pension (SIPP) and has been at the forefront of developments in the SIPP market; self-invested free standing AVC’s for those in occupations pension schemes. A driver for individuals looking to drive their pension’s provision. Francis understands that tax incentivised products such as SIPPs and ISAs stand together for retirement provision. If tax incentivised products can assist first time buyers then that is applauded despite the tax risks. A real evangelist for individuals to take power over their investments and pensions.</sub>