The pros and cons of Lifetime ISAs when compared with occupational pensions
Consider the following question: in respect of a millennial employee (aged under 40, aka “Generation Y”), what does a pension pot offer that a Lifetime ISA (LISA) does not?
The LISA trumps pension pots in three fundamental respects.
1. Pre-retirement access: a free option
Numerous surveys evidence that the under-40s prioritise saving for their first home over contributing to a pension. When buying a first home, LISA savings (including the 25 per cent bonus) can be accessed at any time without penalty.
Given that the upfront incentives paid on a LISA and pension pot contributions are economically identical for basic rate taxpayers (some 92 per cent of all workers under 40), this pre-retirement access to LISA savings is effectively a free option for the saver. By this, I mean that the 25 per cent bonus paid on LISA contributions (made with post-tax income) effectively grosses up the contributions for basic rate taxpayers, akin to tax relief. Therefore, an £80 contribution (from gross income of £100 less £20 tax) plus a £20 bonus (as 25 per cent x £80) takes the total amount saved in the LISA to £100.
2. Post-retirement access: tax free
From the age of 60, LISA savings can be withdrawn tax-free, whereas capital withdrawn from a pension pot is taxable at the saver’s marginal rate. Thus, if the LISA is held until 60, its tax treatment for basic rate taxpayers is effectively entirely tax-free. Pension pots’ 25 per cent tax-free lump sum does not compensate for this: the other 75 per cent of the pot is still taxable.
3. LISA bonuses: major advantages for the low-paid
The LISA provides other significant advantages over a pension pot because its 25 per cent bonus is disconnected from the employees’ tax-paying status. Unlike pensions’ tax relief, bonuses are paid even if total earnings (from one or multiple jobs) fall below the Personal Allowance. In addition, bonuses overcome the “net pay” debacle, whereby those earning between the auto-enrolment trigger of £10,000 and the Personal Allowance make gross contributions but do not receive any tax relief. This currently disadvantages some 280,000 workers, but once the Personal Allowance rises to £12,500 (April 2019) some 500,000 workers are expected to be affected.
Clearly, LISA bonuses make far more sense to low earning (part-time) employees, predominately women, when the alternative may be no pensions’ tax relief. And they should particularly appeal to companies keen to be seen promoting gender equality.
In addition, the widespread distrust of the pensions industry is often cited as a deterrent, whereas the ISA brand is still reasonably trusted.
The advantages of pension pots
Despite the advantages of the LISA, pension pots do hold some advantages, but none of them are material to the typical employee. Yes, higher rate taxpayers would be economically better off with a pension pot, but they are a small minority of the under-40 workforce. But for some of them, even the lure of 40 per cent tax relief is insufficient to overcome pension products’ inflexibility, there being no access to contributions until 55 (57 from 2028). And there is the very real prospect that higher rate tax relief will disappear within the next few years.
Pension pots are sheltered from inheritance tax (IHT), whereas ISAs are not. But how many people in their 20s and 30s are worrying about paying IHT? This pension advantage is a red herring in terms of influencing savings behaviour. In a similar vein are benefits calculations – pension assets are excluded, whereas ISA assets are not, but is this really a serious consideration for employees?
Personalisation is key
For most under-40s, the LISA is the most relevant and tax-efficient vehicle within which to save. It also offers the prospect of boosting employee engagement with saving: ISAs have their owners’ names on them, which engenders a sense of personal ownership. People refer to “my ISA” but they de-personalise their membership of “the company scheme”.
An extraordinary 39 per cent of auto-enrolled scheme members are unaware that they were a member of a workplace pension scheme – Damage by Default: The Flaw in Pensions Auto Enrolment (2017). The majority (95 per cent) had never tried to change their fund, 91 per cent did not know where their funds were invested, 80 per cent did not know how much was in their pension pot and 34 per cent did not know who their pension provider was. Very few have identified a beneficiary, should they die. Personalisation is a prerequisite for engagement.
Ideally, savings derived through work should be as personal as a bank account, unencumbered by the jargon and paraphernalia of pensions. Being in control is closely allied to being motived, and therefore engaged.
Implications for workplace saving
Employers have long complained that their pension contributions are undervalued by employees, and therefore represent poor value for shareholders. Employees should be offered an alternative, that of having their employers’ contributions paid into a workplace ISA. For the under-40s, this could be in the form of a Lifetime ISA, provided through the workplace. It has the potential to act as a catalyst to much greater engagement with saving, and could be cheaply delivered through the new breed of digital wealth platforms (“robo-investing”), which are accessible and convenient to use.
The author is Michael Johnson, corporate affairs and policy advisor at Smarterly.
This article was provided by Smarterly.
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