When George Osborne delivered his Budget on Wednesday it was eyes down as those playing “Budget bingo” listened for the usual clichés; “long- term economic plan”, “hard-working families” and “the northern powerhouse” all got mentions. But among them was a surprising new catchphrase — apparently this was a Budget for “the next generation”.
The chancellor’s big announcement was the new Lifetime Isa, a tax-efficient individual savings account that can be opened by those aged between 18 and 40 from April 6 2017.
This was meant to be Mr Osborne’s big giveaway for millennials — but how much will it actually help them?
Is it simply a ready-made family trust fund for those with wealthy parents? Should young workers ditch their company pension plan and pay into a Lisa instead? And will the housing ladder be more accessible as a result? There are many factors for young savers and their families to consider in the year until its launch.
Introducing the Lisa
The Lisa’s most eye-catching feature is a 25 per cent government bonus. Savers can put in up to £4,000 a year and receive a bonus of up to £1,000 every year — but there are strings attached. Funds must be used to buy your first home (worth up to £450,000) or locked away until you are 60.
Like a conventional Isa, you can hold your money in cash or gain stock market exposure by investing in funds and individual stocks, and your assets will grow tax free. You can access your Lisa from the age of 60, but take out any cash before then and you’ll pay a hefty 5 per cent penalty and lose your government bonus, plus any investment gains you’ve made on that bonus. Ouch.
Mr Osborne said the annual bonus would continue to be paid until Lisa holders reach their 50th birthday, but Steve Webb, former pensions minister, cautioned that the 25 per cent rate could turn out be a “Teaser Lisa” rate, that might fall back in the future.
There are not many 18-year-olds who can afford to save £4,000 a year, but, of course, their parents can help them grow funds in their Lisa to unlock that valuable government bonus.
Paul Traynor, head of insurance and pensions at BNY Mellon, bluntly says: “This is a free money opportunity.”
Christine Ross, head of advice at wealth manager Heartwood, says she expects clients to set them up for their children and use them “as they would a stakeholder pension”. She thinks not being able to access the funds until the age of 60 will appeal to parents who want to provide for their children’s long-term future, an advantage the Lisa holds over the Jisa — or Junior Isa — which releases funds when a child turns 18.
There are obvious inheritance tax benefits for wealthy parents, who can each pass on up to £3,000 a year tax free as part of their annual exemption.
There are other exemptions too — as well as the individual £3,000 tax-free allowance, parents can give away tax-free wedding gifts of up to £5,000 to their children, £2,500 to a grandchild or great-grandchild, and £1,000 to anyone else.
However, outside of the annual allowance gifts are subject to the so-called seven-year rule: they are only tax exempt as long as the parent survives for seven years after making the gift. If the donor dies between three and seven years of giving away their funds, inheritance tax is payable on a sliding scale.
A worker who puts the maximum into a Lisa over a 42-year career could build a fund of almost £700,000, according to calculations by accountancy firm Deloitte. They would have contributed £170,000 and received government top-ups worth £33,000 over that time. The rest of the money would come from stock market growth.
For millennials with affluent parents, helping them to fund a Lisa is too good an opportunity to pass up — but that will not help everyone.
“This risks being yet another perk for the privileged few, and could further exacerbate intra-generational inequality,” says Sophie Robson, author of the Young Money report by consultancy firm MRM. “Mr Osborne is helping people who can afford to save, but if you can’t afford to eat then it’s pie in the sky and it’s distracting from major issues like the rising cost of living for the young.”
Iona Bain, author of Spare Change, a personal finance book aimed at young people, says the “Bank of Mum and Dad” effect would mean millennials from wealthy families would be more able to access the maximum government bonus than those from less well-off backgrounds.
“That’s the problem when you hand out universal bonuses — you’re liable to reward the privileged more than the strugglers,” she says.
House vs pension
Experts warn that the dual purpose of the Lifetime Isa — to save for a house deposit and to save for retirement — could lead to confusion.
Steven Cameron, pensions director at Aegon, says the two aims are “incompatible” as they require very different investment strategies. “If a house deposit is your primary aim, the Lifetime Isa is attractive, but don’t pretend yourself it’s also taking care of your retirement planning,” he says.
By the time you have saved enough for a deposit, house prices in your area could have risen beyond the scheme’s current £450,000 limit.
Antony Summers, private client partner at Thomas Miller Wealth Management, agrees: “With the shortage of properties to either buy or rent, resulting in likely further house price and rent increases, many millennials may well question where they will find the surplus funds to save in the first place,” he says.
Online wealth manager Nutmeg says that it suspected the attractiveness of the Lisa, combined with rising property prices, would lead to pensions “taking a hit” as millennials save for a house instead.
“This is not necessarily a bad thing: people need to buy houses, and houses can be a valuable investment,” says Nick Hungerford, chief executive of Nutmeg.
“But pensions have an important role in setting us up for retirement, when we have little other income to rely on, so it’s important that workplace pensions, auto-enrolment and other pension products aren’t forgotten in the excitement about this great new Lifetime Isa.”
Company pension vs Lisa
Tempted by the Lisa’s 25 per cent annual bonus, many workers in their 20s and 30s will wonder if they should spurn their company pension schemes to pay into a Lisa instead. The short answer is “no” for most people, as the Lisa does not attract valuable employer pension contributions.
In most cases, these employer top ups will be worth more to you per year than £1,000 of free government money. However, although paying money into a company pension is a better idea in the long term, you cannot access any of it early to fund a housing deposit.
Brian Smyth, head of Ascot Lloyd Benefit Solutions, says he was worried that employees in their 20s will now be faced with a “conflict” between paying into workplace pensions and the Lisa.
“If your employer pays into a pension then it would be a bit daft to opt out, to use a Lisa and lose the employer contribution,” says Rebecca Taylor, director at the Chartered Institute for Securities and Investments.
She believes many young people will find the Lisa is “surplus to requirements” as workplace pensions typically offer “much more advantageous terms” by way of employer contributions. Ms Robson agrees: “If young people abandon [company pension schemes] in favour of the Lisa, it could spell disaster for the future of savings.”
So if you can afford both — what then?
What is obvious is that anyone under the age of 40 who can afford to save beyond paying into their workplace pension should consider opening a Lisa. But this is a large age range and what you put into the Lisa will depend on what you’re saving for — a house or a pension.
Broadly, those intending to invest for less than five years should stick with cash, those saving between five and 10 years should look at multi-asset, and anyone saving for longer than 10 years should be looking to invest in equities, says Patrick Connolly, financial planner at Chase de Vere.
Those in their mid-twenties looking to save for a house should be cautious in their investment outlook, says Raj Mody, head of pensions at PwC.
“If you’re saving for five to 10 years and are looking to withdraw your money for a house purchase, then you want to beat inflation but not introduce a massive amount of downside risk, “ he says. “You would be upset with the idea that you could have had ten lots of £5,000 by holding cash but now have less. And you’d be very upset if you had less than £40,000 and had lost your own money — and that introduces a very specific investment goal,” he says.
“You might need to take out the money quickly, so you can’t wait to ride out a market fall,” adds Darius McDermott, managing director at Chelsea Financial. “I think most advisers would say that doesn’t lend itself to volatile stocks.”
But for those just young enough to get a Lisa and use it to boost retirement savings, investing in more volatile products such as equity funds is the way to go, he adds.
“At 39, you’ve got plenty of time before you retire so you can take more risk. I’d even go for something that has not been in favour recently and look at emerging markets or Asian exposure.”
Mr Mody agrees: “You could afford to take some short-term volatility for some long-term growth.”
There are harsh penalties for withdrawal, but Lisa savers could potentially borrow against their funds in future under certain circumstances, according to details released in Budget documents.
“The government will explore with the industry whether there should be the flexibility to borrow funds from the Lifetime Isa without incurring a charge if the borrowed funds are fully repaid,” the Treasury said.
It is looking to a model already in place in the US where savers in popular retirement plans are allowed to borrow up to 50 per cent of their fund, up to a maximum of $50,000, before they reach retirement age.
Known as 401k retirement schemes, the amount borrowed must be repaid with interest over a maximum of five years, although loans for a home purchase can be repaid over a longer time.
Broadly, there are no tax consequences for taking out a loan as long as it is repaid on time.
“You are really borrowing from yourself,” says David John, senior strategic policy adviser with the US-based AARP Public Policy Institute. “However, most responsible financial advisers strongly encourage clients to make this a last resort for borrowing money.”
Mr John says that the most popular reasons for borrowing from 401k plans in the US were to pay college costs and medical bills not covered by insurance.
“Generation Lost”, a study into engaging millennials with retirement saving by BNY Mellon and the University of Cambridge, found that 70 per cent of UK millennials would be more likely to save into a pension product if there was an opportunity to make lifetime withdrawals when needed.
Think for the long term
Finally, there are some important things that a company pension has that a Lisa does not. If your savings are in a pension, and you die before the age of 75, then whatever is left in your fund can pass to your children or any beneficiary you have chosen tax free, subject to the lifetime allowance. If you die at 75 or older, then your beneficiaries will have tax to pay. In contrast, savings held in an Isa when you die may be subject to inheritance tax. However, the Isa value can be passed to a spouse or civil partner tax free.
For young savers, this is a lot to weigh up, but the future reward of a more profitable retirement awaits.
“Humans tend to think in blocks of five years,” adds Mr Traynor. “It is no wonder that convincing a 25-year-old to lock up their money for 30 years can be near impossible.”
What’s better: a Lisa or Help to Buy Isa?
For those saving for a first home, there is a choice to be made between the Lisa and the Help-to-Buy Isa, though the latter will close to new savers in November 2019 and will only be open to new contributions until 2029, making it a shorter-term option.
Both products offer a 25 per cent government bonus for those buying a home. However, while you can invest up to £4,000 annually in a Lisa, attracting a top-up of £1,000, the Help-to-Buy Isa only allows an annual saving of £2,400 and attracts a government bonus of £600 a year. When the account is first opened, savers can deposit a lump sum of £1,000, which will attract a government bonus of £250, meaning the bonus from the first year of saving could be worth up to £850.
The Help-to-Buy Isa has a total bonus cap of £3,000, while the Lisa steadily attracts an annual bonus of up to £1,000 every year for anyone between the age of 18 and 50 — so potentially £32,000 if the government continues to pay out a 25 per cent bonus for decades.
There are also differences between the value of eligible properties — the Help-to-Buy Isa allows you to purchase a house of up to £250,000 if you want to buy outside of London, and up to £450,000 if you want to buy in the capital. The Lisa caps property values at £450,000 across the UK.
If you don’t end up buying a property, the Lisa has heavier exit charges — the bonus is lost and a 5 per cent charge incurred. Help-to-Buy Isas also see you lose the government bonus, but there is no penalty charge.
A final key difference is that the Lisa can hold stocks and shares along with cash, whereas the Help-to-Buy product can only hold cash. Mr Osborne has said that come April 2017, those with an existing Help-to-Buy Isa can roll them into a Lisa, so it is possible to open a Help-to-Buy this year and transfer the cash into a Lisa next April. And you can also hold a conventional Isa account, providing you do not breach the new annual limit of £20,000 split between different products.
This article has been amended to reflect the fact that donations of up to £3,000 a year do not incur inheritance tax even if the donor dies within seven years of making the gift.