This poorly designed product could lead to more pensioner povertyby Ros Altmann / August 25, 2016 / Leave a comment
In the 2016 Budget, the government proposed a new product to add to the tax-incentivised savings landscape—a “Lifetime ISA”—available to people aged between 18 and 40 from next April, in which they can save up to £4,000 a year. Any savings they put in before age 50 will receive a 25 per cent bonus from the government. The money in Lifetime ISAs can be used by first-time home buyers, or kept until age 60 and then withdrawn free of tax.
However, there are suggestions that financial providers may not want or be able to offer the Lifetime ISA by the time of its launch. Some have ruled out participating, others have said they are not sure yet. This is just as well, because Lifetime ISAs have been poorly designed. If the government wants to assist people to purchase homes, then a Help to Buy ISA already exists. But using an ISA product as a pension could be a disaster—it could even destroy pensions.
The behavioural incentives in Lifetime ISAs are wrong for pension saving. With private or workplace pensions, no money can be withdrawn until age 55. Thereafter, people can take as much or as little as they want, with 25 per cent of the fund being taken tax-free. Amounts above the tax-free portion are subject to tax, which provides a powerful disincentive to spend too much too soon.
But with a Lifetime ISA, the entire sum can be taken tax-free from age 60. People will obviously be tempted to take their money straight away, especially as many may fear a future government will want to recover some of the 25 per cent bonus and impose a tax on withdrawals after all. This will increase the risk of more pensioner poverty in future as most of the money will be spent around age 60, with little or nothing left at age 80 or beyond.
Moreover, as only the under 40s can take out Lifetime ISAs, they will not access this money for at least 20 years (withdrawals before then are possible, but penalised). In the meantime, today’s taxpayers will be footing the bill for the government contribution. But this government will be long gone before the effects of Lifetime ISAs as surrogate pensions are known. This is a worst type of policymaking—focusing only on the present while creating problems for the future.
Using Lifetime ISAs instead of pensions will unnecessarily complicate the ISA brand, and will also confuse people who are considering pension saving; younger savers may opt out of their workplace pension scheme to save in a Lifetime ISA instead. But they could then lose their employer’s contribution to a workplace pension scheme and end up much worse off.
Further, ISAs are usually just held in cash, whereas pensions are invested in long-term assets, which generally offer better returns. There are also no controls on ISA charges, whereas employer pensions have much better consumer protections.
Finally, the cost of the ISA reforms announced in the 2016 Budget is estimated at £2bn. Which groups will benefit most from the taxpayer subsidy of Lifetime ISAs? Highly paid under 40s, who can afford to save more than their tax-free annual allowance into their pensions, or who have already hit their lifetime allowance limits will have an added tax-free savings option. Another group could be wealthy individuals who pay into Lifetime ISAs as a gift for their children or grandchildren with the help of the 25 per cent bonus from the government. These are hardly the people who need most taxpayer help for future savings.
The main problem, however, is that Lifetime ISAs are unlikely to last a lifetime. Instead, we need Lifetime Pensions. We could reform pensions tax relief in a far more effective way than just trying to turn pensions into ISAs. The Government needs to develop a simpler incentive system, offering fairer, more effective help to encourage higher contributions, while still disincentivising spending the money too soon.
A flat-rate top-up from the government, more generous than basic rate tax relief and easy to understand (such as an extra £1 for every £3 paid into a pension) would be a sustainable, radical reform that could improve pensions for millions of people. I would not be sorry if the new government consigned the Lifetime ISA idea to the scrapheap.