#Budget2016: Lifetime ISA – an attempt to kill two birds with one stone
The Budget spectacle is usually littered with animal references: rabbits out of hats, foxes shot and so on. This year we can add to the zoological ranks, an attempt to kill two birds with one stone.
A Chancellor faced with a generation struggling to get a toe-hold in an inflated housing market and inadequate levels of pensions saving, decided he would attempt to resolve both with one product.
His answer is the Lifetime ISA. From 6 April 2017 any adult under 40 will be able to open one. They can save up to £4,000 each year and will receive a 25 per cent bonus from the government on every pound they put in.
But the money can only be withdrawn to buy a first property or after the age of 60. Otherwise the government takes back its contribution (and any investment growth) and the saver gets whacked with a 5 per cent penalty, which could amount to many thousands of pounds.
There are undoubtedly arguments to be made about whether funnelling more cash towards a rather toasty housing market is a sensible public policy approach. But my interest lies primarily in what it will do for retirement savings.
My initial impression is that it could work for some people, notably the younger self-employed who have little incentive to put money aside for their old age because they haven’t the carrot of the employer contribution nor the nudge of automatic enrolment. There is some evidence that many worry about locking sums away for long periods when business fortunes can fluctuate. The Lifetime ISA might suit some of them.
However, whether its attractions are enough to break the barriers of inertia that stop many of us saving for old age, and how potential customers will feel about a 5 per cent penalty charge on withdrawal, are seemingly untested.
It is worth noting that the increasingly swollen ranks of the older self-employed will receive no benefit from the product. Yet, we know that many have little, if any retirement savings.
The major drawback of the Lifetime ISA is that it completely fails to build on one of the great public policy successes of our time: automatic enrolment. This requires individuals to actively opt-out of workplace pension schemes if they wish to withdraw and mandates compulsory contributions from employers who stay in. The result, so far, has been six million extra pension savers.
It was a start in moving us away from the individualised approach – you are on your own in saving for old age – that had failed for so long to a partnership between employers, individuals and the state.
This presents a sound framework for the government to build on. But it requires more work to improve current rock-bottom contribution rates, particularly employer contributions, so that pensions saving offered a good chance of providing a decent income in retirement.
Instead the government has opted for the fireworks of a new product over the dreary spadework of building a consensus for increasing contributions.
There is a real risk that some savers, sold on the idea of flexibility and the familiarity of the ISA name will opt to save in these new accounts over workplace schemes. In so doing, they could miss out on valuable employer contributions.
With maths education up to age 18 still a twinkle in the Chancellor’s eye, some savers may overlook that a 25 per cent LISA bonus is worth no more than basic rate tax relief at 20 per cent on pension contributions.
Pensions provide a number of consumer protections. Charge caps on default funds in auto-enrolment make it less likely savers are ripped off by inflated charges. There are also governance safeguards ranging from the more robust system of trustees in many occupational pension schemes to the nascent system of independent governance committees for insurer-provided pensions. There is little sign as yet that LISAs will provide these protections.
And if there is not the system of default funds offered by pension schemes, what will Lifetime ISAs be invested in? Currently 80 per cent of ISAs are held in cash. In a Lifetime ISA cash savings could be enormously eroded by inflation – when it returns.
The ISA system also reinforces the deeply inefficient personal pension system of millions of individual accounts containing, by necessity, highly liquid investments that can be accessed at short notice.
So in a financial services market still beset by complexity, where consumer trust is low, costs can be high and the market’s ability to cater to consumer needs is in doubt, the Chancellor is to launch another new product.
In seeking to kill two birds with one stone, there is a real risk he could miss both.