Lifetime ISAs pension choice
 
On the 16th of March 2016 the chancellor of the exchequer, George Osborne, introduced a new method of saving known as Lifetime Individual Savings Accounts (lifetime ISAs or LISAs for short). It is now time to expose these and determine;


What lifetime ISAs are

Lifetime ISAs are a form of Individual Savings Accounts (ISAs). ISAs are a method of saving whereby any withdrawals and growth are not subject to tax. On the contrary, their funding (contributions) must come from taxed income or more commonly known as take home pay. They are a very tax efficient way of saving though not the most efficient, that title still goes to pensions.

Lifetime ISAs offer the normal ISA tax benefits but also receive a government subsidy on the proviso that the money is either used to purchase certain first homes or any withdrawals are to fund retirement.

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Lifetime ISA rules

Picture guide to how lifetime ISA rules work including age limits, contribution limits and applicable tax rates
 
Commencement date: 6th of April 2017
Age to open account: 18-40
Contribution limits: Up to £4,000 per year (tax year 2017/2018) for those under 50 years old who hold an open account
Government bonus: 25% up to contribution limit i.e. a maximum of £1,000 per tax year
Additional contribution limits: Any contributions plus government bonus count towards the overall ISA allowance (£20,000 in tax year 2017/2018)
Access: Money is accessible at any point, though there may be a penalty attached
Withdrawal charges:

  • For those over 60 years old0% tax
  • Otherwise, for the purchase of a first UK home (not buy-to-let) valued under £450,000 – 0% tax
  • Otherwise, in the case of a terminal illness0% tax
  • Otherwiseequivalent of 24% tax (this comprises of the loss of the government bonus + any interest associated with the bonus (20% of the total) + a 5% charge for early withdrawal (remaining 80% of total))

Investment options: As per normal ISA rules a wide selection of investment classes are available including cash equivalents, individual bonds or shares, or any collective investments authorised by the Financial Services Authority (FSA) or otherwise deemed “UK friendly”

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Advantages

Unlike any other savings option one can benefit from an immediate subsidy with no requirement to either pay this back or even pay tax on it
There will be no tax due on any income, accumulated gains, or withdrawals whilst the money is held within the ISA wrapper
Ability to tailor the choice of investments, and therefore the risk, according to the level of returns required
Should the occasion arise it is possible to fully withdraw all the money held in the account though a small charge may apply

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Disadvantages

Those over 40 or under 18 cannot setup a new policy whilst those over 50 cannot make any further contributions even if they already hold a lifetime ISA
Since only £5,000 can be invested per year the current maximum that could be saved is relatively low for a pension. The maximum achievable savings pot at 60 would be £637,800 with 5% p.a. net real returns (after all costs + inflation) – the equivalent of £2,126 per month (based on 4% p.a. withdrawal rate). Should one only start saving at 30 years old then the equivalent maximum monthly income would be only £1,087
It is currently expected that the lifetime ISAs bonus will only be applied at the tax year end. This will result in a loss of earnings potential compared to pensions which receive immediate tax relief. The loss of interest accounts for up to one year per contribution period. Over a 20 year term this totals in excess of £1,650 (based on the maximum £1,000 p.a. bonus payment being delayed 1 year and 5% p.a. investment returns) and £6,130 if the plan was held from 18-60 (based on the same terms except for no further contributions between 50-60)

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Lifetime ISAs vs Pensions

Lifetime ISAs Pensions
Minimum retirement age 60 55
Age restriction for opening a policy 18-40 None
Maximum age to contribute to policy 50 75 (to receive tax relief)
Bonus or tax relief rate 25% 25-81.8%
Bonus or tax relief application date End of tax year Immediately
Potential loss of interest by 60 Up to circa £6,130 £0
Contribution required to receive £1,000 £800 £550-800
Maximum tax free amount 100% 25/30% (UK/Overseas schemes)
Tax due on rest of withdrawals Not applicable Income tax rate
Tax due whilst overseas Variable Variable
Ability to avoid/minimise tax if overseas No Yes via QROPS
  • The treatment of investments will typically depend on where you are resided for tax purposes
  • Lifetime ISA – The favourable tax treatment of ISAs can easily be negated if you live abroad to the extent that income or gains may be fully taxable
  • Pensions – Tax is based on the rules of the jurisdiction where the pension is held and the country where you reside for tax purposes. Unlike any ISAs it is possible to transfer a UK pension to a new non-UK jurisdiction by using a QROPS. This can allow for a more favourable treatment including reducing the level of income tax that would otherwise be due
Penalty charge for early access Loss of bonus + 5% No early access allowed
  • The treatment of investments will typically depend on where you are resided for tax purposes
  • Lifetime ISA – It is possible to make an early withdrawal without incurring the penalty charge under the following specific circumstances: either in the event of being diagnosed with a terminal illness or alternatively the proceeds are be be used to purchase a first home. In cases where the money is to used for purchasing property the value of the house/apartment cannot exceed £450,000, it must be the ISA holder’s first home, and the property can’t be used for buy-to-let
  • Pensions – Again, in the event of critical illness a pension can be accessed without charge. Also, although one should not be able to start drawing their pension prior to the minimum retirement date it may be technically possible. This is known as pension liberation or pension busting and can result in a typical charge of 55% if HMRC discover that it has occurred
Maximum annual contribution inc bonus £5,000 £40,000+
Ability to use previous unused allowances No Yes
Maximum savings by age 60:
Starting at earliest possible age £637,800 £1,000,000
Starting policy at 30 years old £326,149 £1,000,000
Savings are based on paying in the yearly contribution limit for the maximum allowable timescale and receiving an assumed annual growth rate of 5% after any costs. Further to this, pensions are constrained by the current lifetime allowance (LTA) which penalises savings that exceed this predefined level. Were it not for this limiting factor it would be possible to accumulate a multi million pound pension pot at 60

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Lifetime ISAs – the new default pension choice? written by Liberty Wealth average rating 4/5 - 4 user ratings