5 April 2017
- Launch of Lifetime ISAs – don’t be fooled
- Hardly any providers offering LISAs – probably due to complexity and mis-selling risks
- Mixing house purchase and pensions will damage ISA brand
- LISAs may be good for first time buyers, but dreadful for retirement – saving for house deposit very different from long term investment for retirement
- Trying to turn pensions into ISAs undermines young people’s pension prospects
- Why not just improve the Help To Buy ISA and leave pensions alone?!
The new Lifetime ISA launches tomorrow. Thankfully, most providers have steered clear of it, they can see the dangers. Don’t be misled. If you want to buy a first home and are saving for a deposit, then the 25% Government bonus is a great deal. But using this as a pension has significant dangers you may not be aware of. Most providers are shunning Lifetime ISAs due to fears of mis-selling. They are right. This is a complex product which could leave millions of young people poorer in retirement. It has mis-buying and mis-selling risks written all over it! There is already much confusion and the Pensions and Lifetime Savings Association (PLSA) suggests many young people are considering opting out of their workplace pension to save in a LISA instead. That could undermine their future prosperity, so it is important to clarify some of the biggest issues.
- LISA gives you much less than workplace pensions: The 25% Government bonus is exactly the same as 20% pensions tax relief so you will not get any more money in a Lifetime ISA than you would in a pension. However, you will lose out on other money if you opt out of pensions and choose LISAs instead and you need to understand this before you decide.
- Pensions give you much more than just a 25% bonus: Workplace pensions can give you extra money from employer contributions, higher rate tax relief and National Insurance relief. This could be more than 100% bonus on your money, so pensions will usually give you far more than the Lifetime ISA on day one. It’s just that this is not properly explained when you get your pension statement, so most people don’t realise it.
- The 25% withdrawal charge is NOT just clawing back the 25% bonus. Many people do not realise how the LISA works and will believe they just lose the Government bonus. It’s much more than that.
- The LISA charges more than 6% penalty if you want your money back: If you put £4000 into a LISA and get the £1000 Government bonus but then want to take your money out again, the 25% withdrawal charge will be £1250 (and you will have to also pay charges for your LISA account too of course). That means you will get less than £3750. You will be charged more than £250 just to get your own money back – a large extra penalty.
- Mis-selling and mis-buying risks are clear – customers need advice: LISA providers may not clearly explain the risks of the large withdrawal penalties, and how much money young people will lose if they opt out of employer pensions. The FCA is trying to ensure risk warnings are given, but in reality the provider should check that customers have not opted out of workplace pensions, or have taken financial advice, so they have made efforts to check if a LISA is suitable for them.
- Saving for a house deposit in cash is fine, but cash is not suitable when investing for retirement over several decades: It is dangerous and misguided to conflate saving for a deposit on a first home, with investing over several decades for retirement. House purchase saving can be in cash, but long-term investing should be in growth assets and a broader spread of risks, including overseas investment, which would not really be suitable for a house deposit, but which can give better returns over time. Most ISAs are held in cash and, if pensions are turned into ISAs that are just put into cash accounts, young people are likely to be much poorer in later life.
- Serious risk of undermining the success of auto-enrolment: Pension coverage has spread to millions of new workers as employers have to put all staff earning above £10,000 a year into a pension scheme at work. But worrying PLSA research suggests many young people may opt out of their workplace pension, without realising how much they’d lose by doing so. Just as auto-enrolment is proving a success, along comes a new product to confuse things. It is not true that people don’t like pensions, auto-enrolment opt-out rates are really low, especially among the young. I am pleased that so few providers are offering this product because most young people will be better off in retirement if they use a pension.
- Behavioural nudges of Lifetime ISA are not suitable for retirement saving: The Lifetime ISA has behavioural features that make it far less suitable for retirement saving than a pension. Pensions are designed to fit with the principles of behavioural economics, while ISAs have perverse incentives.
- Pensions ensure more money goes in on day one. Auto-enrolment takes advantage of inertia as well as ensuring employers have to contribute too, so people have more money to begin with in pensions than in LISAs.
- Pensions are locked in until later life, while LISA does allow withdrawals. However, withdrawals face the stiff penalty of over 6%, leaving people with much less in their fund along the way.
- Pensions are taxable on withdrawals beyond the 25% tax-free lump sum in later life. This deters people from spending the money too soon, which is the right behavioural incentive. The incentive with a LISA will be to take all the money out around age 60, and have nothing left for your 80s – in other words, the features of the Lifetime ISA mean it is designed NOT to last a Lifetime.
- Pensions could even help pay for later life care. Pensions encourage people not to spend their money too quickly and, because they pass on free of inheritance tax, there is no need to worry about keeping it till much later life – so it could even help fund care needs if necessary. Young people will have much poorer retirement prospects with LISAs than pensions.
- Lifetime ISAs are great for the wealthy but will cost taxpayers an extra £1billion – is that money well spent? At a time when bereavement and child benefits are being cut, the LISA is going to cost an extra £1billion to the Treasury in the next few years. Two groups of people will most benefit from using a LISA for retirement saving. Firstly, wealthy under-40s who have already filled their pension allowances (perhaps they already have £1million of pensions or have contributed up to the £40,000 maximum into pensions). Secondly, non-earning relatives of wealthy people who have already put the maximum £3600 into a pension for them to get the tax relief and will now get a further taxpayer top-up for an extra £4000 for them. Is this a sensible use of taxpayer resources?
CONCLUSION: Lifetime ISAs should be abandoned. Stop confusing young people between retirement investment and saving for a house deposit – just reform the Help To Buy ISA and build on the success of auto-enrolment for pensions. The product is too complicated, will confuse customers and the last thing we need is another mis-selling scandal.