Lifetime ISA might have been useful in the past but is not necessary now
Pensions auto-enrolment and flexibility will increase pension coverage
New ‘Lifetime ISA’ product proposed, to replace pensions and ISAs: The Centre for Policy Studies is calling for a new savings approach – the Lifetime ISA – to be introduced in the UK. This would replace the separate ISA and pension systems we currently have. The idea is unveiled in this paper http://www.cps.org.uk/publications/reports/introducing-the-lifetime-isa/?utm_source=Michael+Johnson+contacts&utm_campaign=1f6f756838-FTT_chown_lawson&utm_medium=email&utm_term=0_d781b4fd08-1f6f756838-303592833 by Michael Johnson, whose ideas are often worth listening to. Michael is very well-connected in policy circles and has been working on this for several years. The proposals are designed to increase savings levels in the UK, following the dramatic decline in long-term savings, particularly among younger workers.
Pensions coverage will start rising again: It is true that pension coverage has plummeted to record lows in the past few years, and the flexibility of ISAs has proved more popular than inflexible pensions. However, the policy of auto-enrolment under which every worker is joining an employer pension scheme and the new flexibility for pensions introduced in the recent Budget are likely to increase pension coverage significantly in future. The success of auto-enrolment, which relies on behavioural economics to ‘nudge’ people into pensions, coupled with increased flexibility, mean the need to join ISAs and pensions together is significantly lower now.
Tax relief replaced by 50p in £ incentive up to £8000 a year: The proposed Lifetime ISA policy would also mean the end of pensions tax relief, with all savings receiving a 50p in the £ boost from the Exchequer instead (this extra 50p would have to be repaid if money was withdrawn before age 60). A proposed annual allowance of up to £8000 would benefit from this savings incentive top-up, meaning that higher earners would lose out significantly, while the rest of the population received more incentive. In social terms, this makes sense, since one would be redistributing the savings incentives from the highest earners, who presumably need less incentive to save, towards the rest of the population, who probably need incentivising more.
Auto-enrolment offers £1 extra for each £1 contributed, funded mostly by the employer: Tax relief on pensions costs a huge amount – somewhere around £30billion a year – and I suspect the success of auto-enrolment could enable the Treasury to reduce the Exchequer cost of savings incentives in future, while still seeing an increase in pension saving. Indeed, auto-enrolment represents a far more powerful savings incentive than the proposed 50p in the £ for a Lifetime ISA. The auto-enrolment minimum contribution levels offer a ‘buy one get one free’ deal, with an extra £1 going into each worker’s pension fund for every £1 they contribute themselves. Employees put in 4% of their qualifying earnings, the employer contributes a further 3% and 1% more is added by basic rate tax relief, so a 4% contribution immediately doubles to 8%. It is not clear, therefore, whether a 50p in the £ policy is the necessary.
Pension savings can be increased further by auto-escalation: Further ‘nudge’ measures could also be introduced to increase pension savings in future. For example, ‘auto-escalation’ which would encourage people to increase their pension contributions beyond the minimum level, by dedicating a portion of any pay rise to increased pension contributions.
I proposed a Lifetime Savings Account (called ‘LifeSaver’) in 2001 but things have moved on now: Over 10 years ago, I drew up plans for a Lifetime Savings Account, similar to the Lifetime ISA suggestions, which would cater for all a person’s savings needs throughout their lifetime. This is an example from a Paper published in the Journal of Financial Services http://www.rosaltmann.com/pdf/LifetimeSavings_JournalFinServicesJan2003.pdf . I originally suggested that this should be seeded by the Child Trust Funds, which were the forerunner of Junior ISAs. The idea was to ensure people would always have a savings account at every stage of their life. Things have moved on now however. With auto-enrolment, most people will have a pension account once they start work and will also receive extra money from their employer if they contribute. Those who do not save in their workplace pension scheme will forego the employer contribution. The need for a lifetime savings account has therefore diminished and the ability to access pensions flexibly will increase their coverage.
Consider using auto-enrolment for incentivising other types of saving, not just pensions: However, I do think it worth considering allowing workers to use their savings for purposes other than pensions. For example, repaying student debts or saving for a house is a socially valid form of saving, but those who cannot afford to fund debt repayments or house purchase as well as pensions will lose their employer contribution. This seems somewhat unfair. My suggestion is that anyone who saves will receive an employer contribution, but the worker’s own money could be used for purposes other than pensions, while their employer contribution and the basic rate tax relief stay locked until later life.
This would mean everyone saving for their future in some form, with the help of their employer, rather than only offering employer assistance for a pension product and nothing else.
In summary, I am not convinced that we need a new Lifetime ISA. I believe pensions coverage will increase significantly as a result of the policy changes already underway. However, I do believe there is merit in extending the savings incentives to cover other forms of savings beyond just pensions. Those saving for a house or who want to repay student debts should still receive an employer pension contribution, but this employer money and basic rate tax relief should stay locked until retirement, while the worker can access their own savings if needed.