Following much speculation, and not little brouhaha, Mr Osborne resisted the temptation to ‘adjust’ tax relief on pension contributions in his recent budget, instead announcing what some have interpreted as a first step towards a pension ISA, the Lifetime ISA.


Younger savers now have the choice of paying into a traditional pension, using a conventional ISA, or plumping for the new iteration of the tax efficient wrapper, with an annual subscription limit hiked to £20,000 to boot.

The Lifetime ISA, or LISA is for those aged 18 to 40 and has been designed as a cradle-to-grave savings account.

Individuals under 40 will be able to save up to £4,000 a year in the new wrapper, and the government will top it up with a 25% bonus; for every £4 saved the government gives you £1.

The maximum of £5,000 that can be saved in a LISA, which includes the government bonus, will count towards the new annual subscription limit.

Savers then have the choice as to whether they use the proceeds of the LISA to purchase their first property or whether to use it to fund their retirement.

Those purchasing a property can do so after a year of saving into the account, and can buy a home for up to £450,000; those who use the LISA for retirement can continue to contribute and receive a 25% bonus, until the age of 50.

Once the saver reaches 60, money can be withdrawn from the account tax free, but withdrawals for any purpose other than property purchase before that age means losing the government bonus – including any interest or growth – and a 5% charge.

However tough it is for young people to get on the property ladder or to put money away for retirement, the DIY investing revolution is founded on the growing recognition that starting early and investing for longer are key to the achievement of a successful outcome to an investment strategy.

The LISA is designed to be a flexible vehicle that addresses these two key financial objectives and should be considered in the context of alternatives such as conventional ISAs or personal pensions.

Those making the maximum contribution from age 18 to 40 will receive a £32,000 government bonus on the £128,000 they have saved.

‘receive a £32,000 government bonus’

A benchmark for comparing the products available is the amount a saver would have to contribute in order to achieve personally in order to accrue £100, because of the different ways in which they are treated by the tax man.

With no government bonus, unsurprisingly those wishing to achieve £100 in an ISA will need to contribute £100; here there is a clear advantage with the LISA because £100 only ‘costs’ the saver £80 as the government tops it up.

Because tax relief on pension contributions is based upon the individual’s marginal rate of tax, the amount required differs according to circumstances; pensions are taxed ‘on the way out’, and any benefit needs to be weighed against the tax a pensioner will pay on income received after the 25% tax free lump sum is taken.

To a basic rate taxpayer paying 20% income tax in working life and in retirement, a £100 contribution costs £94; a higher rate tax payer needs only to contribute £86 to receive a similar benefit.

If the pensioner pays no tax on income received in retirement, the cost of £100 benefit is £80, the same as it would cost by using a LISA as a vehicle for retirement planning.

Thus, the relative attraction of a personal pension and an ISA wrapper much depends upon the tax band the individual is paying when they contribute and withdraw from the account; generally speaking, higher rate taxpayers are better off paying into a pension because the reduced lifetime contribution limit means that the likelihood of pensioners paying higher rate tax is diminished.

It is estimated that half of basic rate taxpayers will pay no tax in retirement, so purely from a tax perspective a pension and a LISA represent a very similar proposition.

‘purely from a tax perspective a pension and a LISA represent a very similar proposition’

However, with the roll out of auto-enrolment due to be complete by 2017, a key consideration when weighing the options of an ISA or a pension is that of employer contributions.

By 2017 employers will be obliged to pay 3% into their employees’ pensions, added to the 4% employee contribution and topped up by 1% from the government.

Despite some questionable decisions to reduce lifetime and annual contribution levels, a core tenet of government policy is to incentivise people to save and invest for their future.

The LISA does this by offering tax efficiency and a government reward for doing so, whereas those auto-enrolled are incentivised to contribute by being offered ‘free money’ by their employer.

With tax treatment just one of the considerations it is key that the DIY investor chooses the right solution for their individual circumstances and reviews that decision as those circumstances change.

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