Martin Wigginton: Life support system

In the wake of the launch of the Lifetime ISA earlier this year, Martin Wigginton assesses the planning possibilities for UK consumers who are looking to invest tax-efficiently for every stage of their life.

The individual savings account (ISA) welcomed a new member of the stable, the Lifetime ISA or ‘LISA’, in April. LISA joins the Junior ISA (JISA) and the standard ISA – plus a couple of other niche variations – as another tax incentivised means to encourage people to invest for their financial future.

Throw pensions into the mix as well, and the choice of wrappers that can hold investments has rarely looked so generous. When the government introduces a new savings initiative, however, there is a danger it simply makes the financial planning landscape more confusing for consumers.

The government has recently published its response to the consultation on ‘Creating a single financial guidance body’ and will continue to push on with the plan to replace the three existing providers – the Money Advice Service, the Pensions Advisory Service and the Department for Work and Pensions’ Pension Wise guidance – with a new single financial guidance body. This body will have to look much wider than pensions.

The JISA presents a solid first step into the savings and investment culture – anyone can contribute, including parents, relatives and friends. The child can become the registered contact at age 16 but cannot access the proceeds until age 18.

At age 18, the proceeds of the JISA can be taken – or it can convert into a standard ISA. Alternatively, there is nothing to stop some of the tax-free proceeds being used to fund a LISA or a personal pension, where they will attract a 25% bonus up to a maximum of £1,000 a year in the case of a LISA or tax relief in the case of a personal pension.

Behavioural economics

The LISA is a clever piece of behavioural economics, recognising as it does that, for many young people, acquiring a first home is a far more powerful reason to start saving than retirement.  If the money has not been used to buy a property by the age of 60, though, it can be spent however the individual wishes.

A LISA does come with certain conditions to ensure it primarily benefits first-time homebuyers. Before age 60, the proceeds of a LISA can only be used to buy property where the investor has never owned a residential property before. Proceeds must be used as part of a mortgage arrangement – not to buy a property outright – and the property must be valued at no more than £450,000.

In addition, the proceeds of the LISA have to be paid directly to the solicitor or conveyancer, and the property must be intended as the investor’s home, not as a buy-to-let. If any of these conditions are not met or the money is used for any other purpose before age 60, a 25% exit penalty is payable (unless the investor is terminally ill).

LISAs could also complement personal or workplace pensions as under-40s decide best how to save for later life. For some, the LISA could be more beneficial: the LISA’s 25% bonus is equivalent to the 20% tax relief a basic-rate taxpayer can obtain on their pension contributions. But there are some people for whom a LISA may not be more advantageous than a pension – and this needs to be made very clear to potential investors.

They include:

  • Higher-rate taxpayers: The 40% tax relief on pension contributions will be financially more advantageous than the 25% bonus on a LISA.
  • Bigger investors: You can only save £4,000 a year in a LISA, including bonuses, compared with up to £40,000 in a pension, including tax relief.
  • Employees: If an employee opts out of their workplace pension and puts the money in a LISA instead, they could miss out on matching pension contributions from their employer.
  • Early retirees: Money can currently be taken penalty-free from a personal pension from age 55 but not until age 60 from a LISA. This difference will be less for younger savers, however, if plans to raise the minimum pension age to 57 in 2028 go ahead.

Of course, LISAs and pensions are not an ‘either/or’ decision and, ideally, investors can be encouraged to make the most of both. Where intergenerational funding is on offer, then an ISA-based solution seems an attractive option for the parents or grandparent to use. For the workplace, meanwhile, the pension has the power of employer sponsorship and a degree of compulsion.

The UK savings landscape is richer than ever. With the right guidance, any investor should be able to find a permutation of vehicles to suit their life journey.

Martin Wigginton is head of commercial at Cofunds