Building Societies set to embrace Cash LISA
8 June 2017
Comment from Adrian Boulding, Head of Retirement Strategy at Dunstan Thomas
This year will see a steady ramping up of the numbers of providers offering a Lifetime ISA (LISA). And we’ll see the entry of a Cash LISA too, to complement the stocks and shares LISAs that were available on the launch date of 6th April 2017. It’s likely that Skipton Building Society will win the race to produce the first cash LISA, but they certainly won’t be the last as traditional mortgage providers will want to offer this product to prospective first-time buyers saving up for deposits.
It’s as near a dead cert as you can get that the cash LISA for first time buyers will do well. It follows the successful Help to Buy ISA, but has more generous overall limits and is rather more flexible than the Help to Buy which required regular monthly contributions with only one chance, right at the beginning, to pay in any sort of lump sum. The new LISA has a simple £4,000 per tax year rule.
A much more interesting question is whether the LISA will also prove popular as a long-term savings vehicle. Its designers certainly think so, hence the name ‘Lifetime’- supported by the offer of penalty-free withdrawals from age 60. Don’t underestimate the importance of the Government bonus and those penalty free withdrawals – a LISA cashed in at age 60 will deliver 331/3% more than if you cashed it in during your 50’s, combined with any further investment growth on top of that!
We all know you should never buy a product just for its tax breaks and many IFAs have stories of the time they have had to spend talking clients out of purchasing something with a juicy tax bait and into something else because suitability for purpose should trump Government incentivisation every time. But for a customer that wants to save personal contributions over a long period to provide cash in their old age, a pension and a LISA are looking pretty similar, so the relative tax advantage of them will be a relevant consideration.
In our recent consumer study, ‘Engaging with Millennials’, Dunstan Thomas asked the target market whether they believed LISA or Pension was more tax efficient as a retirement savings vehicle. 27% of those we questioned thought that Lisa looked like a more tax efficient savings vehicle than a workplace pension plan, while 34% thought the pension would draw ahead and 38% were unsure.
So we ran the numbers, assuming that the saver was a basic rate taxpayer with access to a salary sacrifice workplace pension, and a basic rate taxpayer in retirement, and that their contribution was invested in a fund that doubled in value during the growth phase. The result was that for £100 of gross contribution, the saver could, at age 60, withdraw the same £170 after tax under both the LISA and the workplace pension.
Advisers will be acutely aware that the answers are highly dependent upon the saver’s marginal tax rate both when the money is paid in and when it is withdrawn. While the former, can usually be accurately gauged as each tax year draws to a close, the latter is a big unknown. Our assumption of basic rate in both cases must apply to millions of people, although we note, from the Institute of Fiscal Studies briefing paper last year entitled ‘The changing composition of UK tax revenues’, that barely half the adult population in the UK pay any income tax at all!
Whilst the value of the tax breaks may look similar, the behavioural drivers are very different for LISA and pensions. The LISA has what many will consider a huge advantage with its ‘get out of jail free’ card. If you change your mind, you can have your money back. Strictly speaking it’s ‘get out of jail’ not ‘get out of jail free’, as once the Government have given a 25% bonus and taken away a 25% withdrawal charge you end up 61/4% down. I have checked with the boffins in the Treasury and this is quite deliberate, not an accident of the mathematics. However, compared to waiting perhaps 30-years to get your hands on pension savings, or losing the lion’s share of them by accessing them through one of the pension liberation scams, what’s 61/4% between friends?
For the self-employed, the un-employed, the gig-economy and zero-hours workers, instant access to your money can be very important. Especially as these people are finding it increasingly hard to raise money through conventional debt finance. It almost seems as if the only people banks want to lend to nowadays are the people that don’t need to borrow anything.
Conversely, some people like the discipline of savings that can’t be accessed however great the immediate temptation to spend is. For them the pension retains its appeal - rather like when, many years ago, china piggy-banks were made without a removable rubber bung in the bottom. The employer contribution is going to be a massive issue, both now and as the LISA builds. We are now almost at the end of the roll out of auto-enrolment (AE), so in pretty much every workplace an employer pension contribution is available to all workers earning over £5,876 per year. Currently, the employer doubles the employee’s 1% contribution, and even at the end of phasing when the balance tilts a bit to 5% from employee and 3% from employer, that’s a lot of money to miss out on if you opt-out.
In the Dunstan Thomas study, 20% of millennials said they were quite or very likely to opt-out of their workplace pension in favour of LISA-based saving. That’s potentially a doubling of opt-out rates, which have remained remarkably stable at around 10% since the launch of AE in 2012. The FCA is on the case. Its PS17/4 paper, released in March this year, extends the required risk warnings to include alerting potential LISA purchasers to the dangers of missing out on matching employer pension contributions.
But are risk warnings effective? They can trigger a perverse human reaction to do exactly the thing we are being warned against, a trait famously sent up by John Cleese in his “Don’t mention the war!” sketch in the Fawlty Towers series.
And if we do see lots of people missing out on employer pension contributions by switching to LISA, what sort of policy response should we expect from Government? An advertising campaign extolling the virtues of pensions? I think a more likely response would be a change of AE legislation to facilitate those employer contributions being re-directed to a LISA or ISA of the employee’s choice!
I’m becoming increasingly convinced that there is room for both pensions and LISA to flourish in the long-term savings market. And that the deciding factor for customers will be their preference for inertia or engagement.
Workplace pensions offer all the benefits of inertia: no complicated forms to complete as the employer chooses a provider for you, the trustees choose the investments for you; and the Government chooses the contributions levels and caps the charges for you. Slam dunk!
But the LISA is those who want to sit in the driving seat. Hopefully with the help of a good adviser, choices abound and the customer is in control of what to pay and where to pay it. Please, just don’t fall asleep at the wheel and leave a short-term decision to invest in cash as the home for your savings for the next 30 years.
Adrian Boulding is Director of Retirement Strategy at Dunstan Thomas
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