The launch of the new Lifetime Isa could shift employer views on workplace savings schemes for younger workers paying tax at the basic rate, pension experts are warning.
Figures from Willis Towers Watson show that where withdrawals attributable to new pension savings would be taxed at 20 per cent, the current system is equivalent to a 6.25 per cent top-up after the tax-free lump sum is taken into account. This is significantly less than the Lisa’s 25 per cent top-up. For a 40 per cent taxpayer who expects to pay 20 per cent tax in retirement, pensions tax relief is equivalent to a 41.67 per cent top-up. The extent to which workers might prefer Lisa to workplace pension will depend on the amount of the employer contribution, but for those paying basic rate tax in work and in retirement, the auto-enrolment minimum equates to £5 for each £4 foregone to a Lisa that retains the flexibility of withdrawal, compared to £6.40 into a pension.
Under-40s can invest up to £4,000 a year tax-free in Lisas from April 2017 and benefit from a 25 per cent Government bonus on savings made before age 50 and take out the proceeds tax-free and charge free to purchase a home or for anything else at any time after age 60.
Portus Consulting commercial director Steve Watson says: “This potentially turns everything on its head in terms of pensions and savings in the workplace following the success of auto-enrolment.
“Over and above minimum pension contributions required by auto enrolment, employers could start looking at workplace savings schemes such as a Lifetime ISA as an alternative to pensions. For younger workers and low earners Lifetime ISAs and schemes such as Help to Save may be more relevant.
“The Chancellor is saying pensions are still too inflexible and hard to understand. The tax benefits remain very important for older workers and it is good news that the tax-free lump sum at age 55 has been preserved but retirement planning decisions are no longer as straightforward. The introduction of a Lifetime Isa could pave the way for a Pensions Isa”
Willis Towers Watson senior consultant David Robbins says: “It was widely believed that the Chancellor favoured turning pensions into ‘help to retire’ Isas – contributions would come from taxed income, withdrawals would be tax-free and the Government would add a top-up in between. George Osborne’s Budget speech said only that there was ‘no consensus’ for this, and not that he had been persuaded it was a bad idea.
“The Lifetime Isa looks like a foot in the door for more radical change. Once the infrastructure is in place, contribution limits and top-up values can easily be tweaked and the age limit reduced. If Lisas prove popular, this will strengthen the Chancellor’s hand. However, if the end game is for Lisa to replace pensions, there will need to be a way for them to accept employer contributions with tax siphoned off and a top-up applied.
“Where the money saved in a Lisa is left there until retirement, the comparison between the 25 per cent Government bonus and pensions tax relief depends on the tax the individual pays both in work and in retirement, and on whether the pension contribution comes from the individual or is offered by the employer as an alternative to salary.
“For a basic rate taxpayer contributing out of their own pocket, the Lisa top-up will be no better or worse than pensions tax relief if they pay no tax in retirement. Where withdrawals attributable to new pension savings would be taxed at 20 per cent, the current system is equivalent to a 6.25 per cent top-up after the tax-free lump sum is taken into account, so the Lisa’s 25 per cent top-up is much better. However, for a 40 per cent taxpayer who expects to pay 20 per cent tax in retirement, pensions tax relief is equivalent to a 41.67 per cent top-up – that trumps the 25 per cent on offer through a Lisa. As this shows, 40 per cent taxpayers who shift tax bands after retirement should feel most relieved that a radical overhaul of pensions tax relief has been put on hold.
“National Insurance relief on employer pension contributions, which has been reprieved in the Budget, means that an employer’s money will go significantly further if paid into an employee’s pension than if used to provide salary that is saved into a Lisa after tax and NICs have been deducted. Where an employee pays basic rate tax both when working and in retirement, an employer willing to spend £1,000 can provide £850 of disposable retirement income through a pension or £747 through a Lisa.
“Allowing the Government bonus to be put towards the cost of a first home may not help first-time buyers as a group. If two Lisa savers bid against each other for a home, it is the seller who will benefit from their capacity to pay higher prices. Ironically, it may do more to improve the lifetime wealth of first-time buyers if they collectively locked more money away for retirement and offered less for the homes they want to buy. However, if the people you are competing against in the housing market are dipping into their retirement savings, you may feel obliged to as well.
“Undoubtedly, the inaccessibility of pension savings limits how much people are prepared to contribute, especially when retirement is a long time away. On the other hand, saving in a pension means you only have to resist temptation at the time you make the contribution, not every day.”