ISAs and ever-changing options for long-term savings

Customers in the UK have never had so much flexibility in how to save for the long term.  Following the recent launch of the Lifetime ISA (LISA), we take a look at the role that individual savings accounts (ISAs) can play in retirement savings.

The aim of the LISA is to facilitate savings for either first time home purchase or retirement.  However, before considering the impact of this new product, there is evidence that ISAs are already playing a significant role in retirement savings.  If we look at both the number of people over 65 holding an ISA and the average ISA fund size for this group, we can see that ISAs appear to be a popular savings vehicle for retirees and have the potential to contribute significantly to retirement income.

Source HM Treasury ISA statistics

Source HM Treasury ISA statistics

Clearly there are many drivers behind this:  

• Over 65s have had longer to contribute to their ISAs and have generally benefited from longer investment returns;
• Saving tends to happen more in the later phase of working life, when salaries are higher and debts are more likely to be paid off and;

• Perhaps in the days before Pensions Freedoms, ISAs were seen as a more flexible vehicle for top up savings than traditional defined contribution pensions.

With government incentives such as the LISA being launched, as well as younger generations being less engaged with pensions, the trend towards ISA based long term savings looks set to continue.

Introducing LISA

LISA was announced at the 2016 Spring Budget in the midst of rumour that the government was intending to move away from the traditional exempt/exempt/taxed pensions environment.  Although this rumour did not come to pass, many still see LISA as the first step in this journey.

This product works in a very similar tax environment to normal ISAs, but with a few specific rules.

1. It can only be opened by people who are under the age of 40 (and over the age of 18);
2. Customers can keep contributing until the age of 50 and;
3. LISA savings can be accessed to help purchase a first home (which cannot be valued at more than £450,000) or after age 60 for any purpose.  Accessing LISA savings in any other circumstances results in a penalty of 25% of the withdrawal amount being applied.

As with other ISAs, contributions are made from net pay and are entirely free from tax while invested and on withdrawal.  The main attraction of the LISA is the bonus payable by the Government .  For every £4 that an individual pays in, the Government will add a further £1, up to a maximum contribution from an individual of £4,000 per annum.

Pensions, ISAs or LISAs?

Although all three wrappers have tax efficiencies, the main difference is that for many people pension contributions are paid from gross salary so tax and NI are not paid on pension contributions whereas ISAs and LISAs are paid out of net salaries. The government bonuses on LISAs achieves a similar effect for lower rate tax payers but of course there is no matched employer contribution.

This does mean that for self-employed people, the difference between a pension and a LISA is slightly less marked, particularly if they aren’t looking to contribute more than £4,000 per annum.

In retirement, the main difference is that the ISA or LISA savings can all be taken tax free, whereas a pension will only have a 25% tax free lump sum with the remainder being taxed as income.  This means that a combination of (L)ISA and pension may give the most tax flexibility and benefits for retirees.  However there is more than just tax efficiency for customers to take into account, the increased governance arrangements around pension schemes, in particular the caps on charges as well as the range of investment choices available, can have significant impact on product performance.

So are customers interested in this new product?  We saw from our own survey last year, that 61% of under 40s were considering opening a LISA and of that group, 68% would be intending to do it in addition to their pensions savings.  And although we can’t extrapolate a huge amount from the first day sales figures, there were around 5,000 applications for LISA on the first day of the tax year, which shows a reasonable amount of interest in the new product.

An opportunity for providers?

So far, only Hargreaves Lansdown, Nutmeg and The Share Centre, have launched a LISA.  However, others plan to launch over the course of this tax year and Skipton Building Society has confirmed that it will launch a cash LISA in June.

Some providers may be waiting to see how the product is received and others may be making sure that their systems can cope with some tricky administrative issues. This is the first product where a Government bonus is added on a regular basis which involves complex data feeds between Treasury and the provider.  

However, in these times of political change which have seen significant changes to the pensions regulatory environment, we are experiencing more and more use of the ISA wrapped investments for long term savings.  The introduction of new ISA variants and the increase in overall ISA subscription levels (now at £20,000 per annum) which is in direct contrast with the reduction in the annual pension allowances could show the direction of travel and the potential future of the long term savings market. If young people are to embrace the LISA as part of their retirement savings, there is potentially a large section of funds under management for providers to win.

Contributing authors:

Karen Brolly    Elaine Murphy

The material and charts included herewith should not be considered a definitive analysis of the subjects covered, nor is it specific to circumstances of any person, scheme or organisation. It is not advice and should not be relied upon. Hymans Robertson LLP accepts no liability for any errors or omissions.