The Government has announced it will scrap the much-criticised 5 per cent penalty fee for those who cash in a Lifetime individual savings account (LISA) during the first year. While it’s good that politicians are listening to criticism of the new product, any extra complexity is always a barrier to consumer understanding. And don’t forget that half of savers in the UK don’t even know what ‘ISA’ stands for*.
The LISA - a complex hybrid between a pension and an individual savings account - is due to launch in April, and yet the Government is still making up the rules as it goes along. It could be revolutionary, but the new product has not been properly thought through.
What is it?
The LISA will allow those aged at least 18 and under 40 to save up to £4,000 a year and receive a government bonus of 25 per cent.
The bonus, which is capped at a maximum of £1,000 a year, must be used either towards a deposit for a first house or for retirement. Should you withdraw money for anything else, you will lose the bonus and face a 5 per cent charge.
The Treasury’s decision to waive the charge for the first year was made because in that year the Government bonus will be paid at the end of the tax year, rather than monthly, as will be the case in subsequent years.
But having one set of rules on withdrawals for 2017/18 and another for the year after, as well as moving from annual government top-ups in 2017/18 to monthly ones in 2018/19, looks too confusing to me. Read that sentence back. It’s not something I’d like to have to explain to an 18-year-old.
Will it work?
The Lifetime ISA could be a much-needed incentive for those who currently find it hard to save. It also has great potential to benefit the self-employed and low-paid who do not quality for auto enrolment pension scheme benefits. Plus, it could help to encourage earlier engagement with retirement savings. So far, so good.
However, critics warn of unintended consequences. There is a big danger that the LISA could encourage younger savers to opt out of automatic enrolment pension schemes, which would result in a loss of employer contributions. After decades in which it was impossible to get young people to save, automatic enrolment has seen more than two million under-40s enrolled into a workplace pension with an employer contribution. To undermine this through a rival product would be snatching defeat from the jaws of victory.
Also, while the LISA's exit charge may be aiming to drive the right behaviours, it makes the product complicated and damages the ISA brand, popular until now for its total flexibility of access.
Another point of contention is the cut-off age of 40. Around 4.6 million self-employed people are not covered by auto enrolment, many of whom are aged over 40. Plus, a growing number of over 40s have not yet made it onto the first rung of the housing ladder.
The Financial Conduct Authority (FCA) has already said that the Lifetime ISA should come with ‘risk warnings’ at the point of sale. In particular, the watchdog said the risks of losing out on an employer's pension contribution should be made clear by LISA providers. The FCA also wants providers to inform consumers that they may not be optimising their retirement savings from a tax perspective if they choose to invest in a LISA rather than a pension.
I think the LISA smacks of a pilot scheme for a new pensions regime, disguised as an ISA to take advantage of the latter’s popularity and to avoid more accusations of messing with the pension rules. For years, governments have wanted to withdraw higher-rate tax relief on pension contributions. The LISA offers a solution.
ISAs are undeniably more popular than pensions, and their appeal may help draw people in. But a big part of their popularity lies in their simplicity, and the LISA could undermine that reputation. There are already five types of ISA – cash, stocks and shares, Junior, Innovative and Help to Buy. The Lifetime ISA will be the sixth, so it’s getting really confusing.
Meanwhile, if you want to save for a deposit on a house between now and April, don’t wait for the LISA. Instead, start a Help to Buy ISA, which adds 25 per cent to first-time mortgage deposits. Barclays’ Help to Buy ISA has the best universally available rate at 2.27 per cent, and if you have a Cumbria postcode, you can get 3 per cent with Penrith Building Society. You will then have the option to transfer a Help to Buy ISA into a LISA until April 2018.
Moira O’Neill is Editor of Moneywise magazine and www.moneywise.co.uk
* According to research commissioned from YouGov Plc by Aldermore Bank. Total sample size was 2049 adults. Fieldwork was undertaken between 19th - 22nd February 2016. The survey was carried out online. The figures have been weighted and are representative of all GB adults (aged 18+).