This year's Budget brought with it two new Isa surprises in the form of a Lifetime Isa (Lisa), designed as a form of pension or first-home fund for under 40s, and an increase in the annual Isa allowance to £20,000, up from £15,240.
The new Isa will enable those under 40 to take home a government bonus of £1 for every £4 saved each year to put towards a first home or retirement. But it brings with it a tricky choice for under 40s, who will have the choice of paying any excess income into a pension or the new 'Lisa', which they could use to fund a first home or their retirement. The Lisa is not designed as a pension replacement, but some young investors will have to make a choice between the two. And for those worried about locking up their cash in a pension until age 55, the ability to access Lisa cash, albeit with an exit penalty, may be appealing.
How the two compare
■ Government bonus. For basic-rate taxpayers, the tax relief on pensions works out the same as the government cash boost with Lisas. This is because the 20 per cent tax relief you get on your pension is from pre-tax gross income: for a pension contribution of £100 you only pay £80 and receive 20 per cent in tax relief, while the 25 per cent Lisa bonus you receive is on taxed income, or net income, so it works out as equivalent. However, higher-rate taxpayers and top-rate taxpayers receive a far higher boost from pensions as they are able to claim back up to 40 or 45 per cent in tax relief.
■ Tax treatment. Isa cash is taxed on the way in - it is money you have already paid income tax on - but can then be taken out tax-free. Whereas with pensions you receive upfront tax relief but are taxed on the way out. That means a basic-rate taxpayer could take £5,000 from a £5,000 Lisa pot but would only be able to take home £4,200 from a pension pot of the same value, assuming 25 per cent tax-free and 20 per cent tax on the remainder. However, the Lisa government bonus means it is in effect exempt from tax on the way in.
■ Employer contributions. If you save into a workplace pension you receive an employer boost as well as a government top-up, but you cannot receive employer contributions into an Isa.
Ideally, you should save into both a Lisa and a pension. For higher-rate taxpayers, pensions are far more generous sources of tax relief and you can pay more in. Basic-rate taxpayers should make sure they make the most of employer contributions into a pension, but also make the most of the new flexible saving product which enables them to take the money out if they really need it.
Richard Perkin, head of pensions at Fidelity International, says: "It will clearly remain best advice for people to stay in their workplace pension and get any employer contribution available to them. But saving in a pension beyond this level may be questionable. Generally, anybody paying basic-rate tax today will be better off making additional saving in a Lifetime Isa rather than saving in a pension."
How much could you save? Ben Stanway, co-founder of savings and investment app Moneybox, says: "A 25-year-old saving £4,000 a year (£333 per month) until 35 into a cash Lisa could end up with £52,000 - £10,400 more than with a regular Isa - to put towards a house. £10,000 comes from the government bonus, providing a huge boost in these times of low interest rates. However, the biggest winners could be those investing Lisa savings into stocks and shares, benefiting from the power of compound interest. As an example - based on historic returns of 5.5 per cent - a 25-year-old investing £330 per month until the age of 60 into a Lisa could end up with £546,000 - an extra £106,000 compared with a regular Isa." |
Lifetime Isa key features ■ Save up to a maximum £4,000 each year and receive £1,000 from the government - a 25 per cent top-up - from April 2017. ■ Savers earn the bonus between 18 and 50 years old once Isa is open. ■ Counts towards the new £20,000 Isa subscription limit and can be invested in stocks and shares or cash. ■ After one year savings can be withdrawn tax-free to buy a home worth up to £450,000, otherwise the Lisa must be left undrawn until age 60. ■ If savers withdraw money before 60 other than to buy a home they face an early exit penalty of 5 per cent and forego the bonus, as well as any income or growth on that bonus. ■ Anyone already saving into a Help to Buy Isa can roll it into a Lifetime Isa or maintain both. Only one government bonus may be put towards a deposit. |
The exit penalty in practice Lowes Financial Management managing director Ian Lowes says: "Imagine you invest £4,000 and the government adds £1,000, giving you £5,000. This doubles to £10,000 as a result of investment growth. You choose to withdraw £1,000 (£400 of your original capital + interest and growth + £100 original bonus + interest or growth). You have to pay back £200 (20 per cent) + 5 per cent charge on the balance, leaving you with £760 of your withdrawal - 24 per cent less than it was worth. |
Pension versus Lifetime Isa
| Lifetime Isa | Pension/Self-invested personal pension (Sipp): basic-rate taxpayer | Pension/Sipp: higher-rate taxpayer | |
| When available | 6/04/17 | Now | Now |
| Age you can start | 18-40 | Any age | Any age |
| Upper age limit for paying in | 50 to qualify for bonus | 75 | 75 |
| Annual savings limit | £4,000 per year, no bonus above that | £40,000 | As little as £10,000 for higher-rate taxpayers. From 6 April 2016, limit of £40,000 reduced by £1 for every £2 of income in excess of £150,000 |
| Lifetime savings limit | No upper limit | £1m (from 6 April) | £1m |
| Impact on Isa savings | Counts towards limit | Doesn't count towards limit | Doesn't count towards limit |
| Investment options | Cash or stocks and shares | Some restricted to limited funds list, others include wider range of investments | Some restricted to limited funds list, others include wider range of investments |
| Tax on investment growth | None | None | None |
| Government incentive | 25% bonus (max £1,000 per year) | 20% tax relief (equivalent to 25% bonus) | 40% tax relief |
| Age you can access | 60 or earlier to purchase home worth £450,000 | 55 | 55 |
| Tax treatment on proceeds | No tax if adhering to rules above | 25% tax free with remainder taxed at marginal income tax rate (20%) | 25% tax free with remainder taxed at marginal income tax rate (40%) |
| Employer contributions | Not allowed | Required for all relevant employees aged 22 and over | Required for all relevant employees aged 22 and over |
| Treatment on death | Part of estate so subject to tax | Not part of estate | Not part of estate |
| Early-access penalty | 5% and return of government bonus and interest/growth on that bonus | On older lifestyle company pensions | On older lifestyle company pensions |
Source: AJ Bell YouInvest and Aegon
CGT cuts could change your style Capital gains tax (CGT) cuts in the Budget mean it could be better for income investors to take profits rather than buy income-generating investments. From 6 April the higher rate of CGT will be cut from 28 per cent to 20 per cent, while the basic rate will fall from 18 per cent to 10 per cent. The cut makes the 20 per cent or 10 per cent tax levied on investments sold at a profit far more appealing than 40 per cent income tax on income-producing investments for higher-rate taxpayers, or 20 per cent income tax for basic-rate taxpayers. Simon Bashorun, financial planning team leader at Investec Wealth & Investment, said: "The increase in the distance between income tax and CGT rates will make drawing on capital each year as a form of 'income' even more attractive than it currently is. This reinforces the need for individuals to build up portfolios that can provide gains to draw down on tax efficiently in the future." Jason Hollands, managing director at Tilney Bestinvest, says: "Investors who have maxed out pensions and are already fully funding Isas are increasingly going to have to invest in a taxable environment in growth rather than income-generating investments. Regularly crystallising capital gains is going to be an increasingly important source of providing cash in their retirement. "Of course, some may be able to achieve complete tax-efficiency through using their annual CGT allowance [of £11,100], but for those needing to go further, 20 per cent CGT is much more palatable than taking income and being hit with 40 per cent income tax. A sensible strategy for these investors could be to focus on yield-generating investments within Isas and capital return funds outside of tax wrappers, while avoiding drawing on their pensions for as long as possible given their efficiency from an inheritance tax perspective." |
