Forget ditching the Lifetime Isa – it should be evolved instead
Last week, the Treasury Committee suggested that the year-old Lifetime Isa (Lisa) be killed off.
This news came hot on the heels of rumours that the pensions dashboard might get the boot, just months before it was expected to go live.
This government seems to have a knack for driving in reverse. And by failing to stick to a coherent policy, MPs are adding another layer of confusion to an already painfully convoluted pensions system.
We should be concerned that the government is considering dumping two ideas that resemble what pensions should actually look like in the twenty-first century.
I said my bit on the pensions dashboard last week, so now it's time to stick up for the Lisa.
Introduced by George Osborne in 2016, the Lisa is a savings vehicle with a 25 per cent government bonus. It can be opened by anyone aged between 18 and 39, but savings must be used to buy a first home or for retirement.
With just a handful of providers offering the Lisa since its launch 16 months ago, it hasn’t taken off in the way the government was expecting. And it is not without its flaws – evident from the barrage of criticism that has surrounded this hybrid Isa right from the outset.
The premise of a Lisa is simple, because people understand the idea of the government topping up their pension Isa more easily than the process of claiming back tax relief
Mixed bag
A savings product designed for two different goals doesn’t make sense, particularly when it usually takes decades longer to save for retirement than a house.
From a house-saving perspective, the Lisa simply doesn’t work.
Former pensions minister Steve Webb, who is now the director of policy at Royal London, says: “It is far from clear what problem the Lifetime Isa is trying to solve. For first-time buyers, there is already a Help to Buy Isa, which could have been expanded and improved.”
He is right. The Lisa slaps you with a 25 per cent penalty if you withdraw funds for any reason other than house-buying or retirement, which means that you lose a quarter of any growth too. So, given the choice, many people opt for the flexibility of the Help to Buy Isa instead.
With this in mind, there’s something to be said for removing the housing part of this product and turning it into a simpler pensions Isa instead. Indeed, from a pension perspective, it has a lot to offer.
Reward versus relief
The Lisa’s 25 per cent government bonus is paid monthly, which looks pretty tasty from a compounding perspective. Moneyfacts figures indicate that the average annual return for UK pension funds sits at 10.5 per cent – so with an extra 25 per cent on top, savers can see how their money can make them more money.
The Lisa’s bonus also marginally beats the 20 per cent tax relief offered to basic-rate taxpayers through a pension scheme.
Bear in mind, though, that employer contributions would make pension tax relief almost equal to the Lifetime Isa bonus – so the difference is tiny, and certainly doesn’t warrant opting out of your workplace pension scheme.
“For long-term saving, workplace pensions benefit from tax relief and, crucially, an employer contribution as well,” says Webb, urging savers to “max out” on what your employer will contribute first, before looking at the Lisa.
Simple psychology
Part of the problem with pension tax relief is that it’s not very well understood by the younger generations.
This was highlighted last year, when almost half of the millennials surveyed in a BritainThinks poll thought that higher-rate taxpayers would be better off with a Lisa than with a pension.
There are two options: either young people need to be educated about finance, or the government needs to make the pension regime easier for people to understand in the first place.
The premise of a Lisa is simple, because people understand the idea of the government topping up their pension Isa more easily than the process of claiming back tax relief – even if the amounts are the same. So perhaps the rest of the pensions system should be aligned with the Isa, rather than the other way around.
A bonus also feels more like a reward than tax relief does. Even the Treasury Committee agrees that tax relief on pension contributions is not an effective way of incentivising saving.
Rewarding people with a bonus encourages them to save more. And in the long run, a bonus system mentality could go a long way to closing this country’s huge pensions gap.
Tech take-up
Finally, the Lisa is available entirely online, which gives it the edge over many pension schemes. One glaring reason young people don’t engage with their pensions is because many providers don’t take advantage of the technology to make it easy for them.
But with a Lisa, savers can log in to their account at any time, choose their own investments, and manage their money without having to struggle with clunky processes from the dark ages. The entire pensions industry should be going digital, and yet the government is threatening to abolish one of the few online pension products in the market.
Also bear in mind that take-up of the Lisa is starting to gain decent traction. AJ Bell’s Tom Selby says around 200,000 accounts have opened to date.
Indeed, Selby reckons that scrapping the Lisa now would be “bizarre”. “Those who criticise the Lifetime Isa do so on the grounds that it is too complicated and doesn’t complement traditional pensions,” he says. “On both fronts their protestations are misguided.”
The idea of a simple, online-only pension product topped up by the government is a strong one.
No one is saying that the Lisa is perfect. But it makes more sense to fix the problems, cut the house-saving element, and improve it, rather than ditching the whole thing entirely – particularly when young people are finally showing an interest in their savings.