Lifetime ISA – a Trojan horse for long-term saving, or a blessing?

The arrival of the new Lifetime ISA in April 2017 seems likely to be a harbinger of wider change in the UK’s approach to long-term, and indeed retirement, saving. The creation of the new ISA has been widely acclaimed by the popular press, but will it do more harm than good as it seems poised to impact on existing policies, such as Automatic Enrolment into pension saving?

First, the details of the Lifetime ISA as we have them so far.

Savings of up to £4,000 per annum can be made as part of the overall ISA allowance of (also from April 2017) an increased annual amount of £20,000. A government “bonus” of up to £1,000 will be paid, representing an effective tax relief rate of 25% better than the 20% relief rate available to a basic rate tax payer contributing to a pension arrangement.

The ISA must be started before age 40, with continuing contributions possible until age 50. Access to the fund is possible to buy a first home, or at age 60 or over, with proceeds, including the bonus and fund growth, tax free.

Early access to the fund will be possible, but the bonus must then be repaid and in addition an exit penalty of 5% will need to be paid! This is deeply ironic from a government that has recently been lambasting exit fees on pensions provided by the private sector; one rule for government, another for everyone else.

ISA vs Pension debate

So, a relatively simple rule set leveraging the ISA “brand”. Saving for the deposit on a house just got easier, and the Lifetime ISA will replace the Help to Buy: ISA. A foot on the property ladder is a priority for many under-40s, and the Lifetime ISA is likely to prove very attractive to this age group.

But will the under-40s choose to prioritise saving in this way over saving into a pension through the Automatic Enrolment regime, where people are saving into a pension plan with employers making contributions alongside them? And if they do, is it the right course of action?

The combination of tax relief and “free money” from your employer SHOULD nail the argument in favour of pensions, alongside Lifetime ISA saving, but there is only so much money to go around, and I suspect we will see people opting out of pension saving to prioritise buying that first home.

The Lifetime ISA idea has been widely vilified by pension commentators, perhaps not unnaturally, as an existential threat to conventional pensions. However, this ignores some uncomfortable truths. The first of these is that people will buy into, keep buying and put more money into, savings architectures that they understand.

“Pensions” are now beyond complex, with the “taper” on tax relief for higher earners just the latest arcane measure to affect the architecture. Even pension experts struggle to fully understand the rule set around pension saving – in which case, what chance does the man or woman in the street have of comprehending it?

Constant “tinkering” with the rule set also makes it almost impossible to plan ahead with confidence; what you can do today, may be impossible to do tomorrow. Much of this “tinkering” is at least ostensibly to do with protecting the tax relief on contributions to pensions from perceived “abuse”, or even the potential for it.

By contrast, the ISA “architecture” is understood by most and is relatively simple in its rule set. It is clear that many people are already using “stocks and shares” ISAs for retirement saving purposes. Until “freedom and choice” arrived, ISAs enjoyed clear advantages over pensions in terms of flexibility, and still do so today in terms of tax efficiency in later life income planning.

The second is that people are already using a wide range of vehicles in which to save and invest for later life, other than ISAs or pensions. Research over recent years at the Institute of Directors revealed over 20 different ways that members were putting money aside for later life. From buy-to-let property to stamp collecting to fine wine, it was clear that even quite modest savers were using a surprisingly diverse set of approaches to long-term investment. It is also clear that this trend is accelerating, driven by some of the factors identified above. Where people have a choice, they are often choosing not to use the pension savings architecture we have today.

If the advent of the Lifetime ISA encourages more people to engage with conventional saving and investing, this can only be good news. Long-term saving for retirement or later life is not a hard concept for people to grasp. If we make it easier to do, more people will do it.

I am aware of some financial advisers who will no longer advise clients on pensions because of the constantly changing rules potentially making advice given today, bad advice tomorrow. If we have got to this position, surely we need to think of other, simpler, approaches to the issue. And we can see from the quantum of assets saved for the long term in ISAs that people are already voting with their feet.

'Free money' from employers

Ah, say the pension defenders, you are ignoring the value of employer contributions to pension plans and of course, today, that is true. But one of the groups likely to “buy” the Lifetime ISA approach are the growing army of the self-employed, now in record numbers in the workforce. They are exempted from the automatic enrolment regime and are today making apparently worryingly low pension savings.

However, I reference my comments above; they may well be saving for retirement, but just not in pensions. We just can’t tell. And my betting is that, perhaps soon, employers WILL be allowed to make contributions alongside their employees, into the Lifetime ISA architecture. A situation whereby two “systems” exist in parallel – pension (perhaps with greatly reduced or restricted tax relief), and Lifetime ISA – is not hard to envisage.

The question then is which system would prove most popular with employers and their employees, who are the ultimate arbiters of choice in the matter. But either way, if the end result is more people, saving more money, for the long term and retirement, it will represent the kind of “win-win” result for both ordinary people, and the financial services industry, that we have seen all too rarely in recent decades.

And that is surely the sort of prize worth aiming for.

Guest blog from Malcolm Small