A free handout of up to £32,000 in cash from the government is, it has to be said, the sort of offer that grabs your attention. That’s the carrot George Osborne held out to younger people this week – presumably in an attempt to placate Generation Y’s anger about never being able to afford to buy a house and having to work until they drop because they have been shafted on pensions.
But does the new lifetime Isa stand up to scrutiny? Here are four reasons why you should take one out, and two reasons you shouldn’t.
Why you should
1. It’s free money
The lifetime Isa, available from April next year, is a savings account that will allow you to save towards your first home or your retirement. It’s only for those under the age of 40 in April 2017: individuals will be able to open a lifetime Isa from the age of 18 until they turn 40.
You can save as little or as much as you want each month, up to £4,000 a year. The government will then provide a 25% bonus on these contributions at the end of the tax year. This means those who put in the maximum each year will receive a £1,000 bonus every 12 months from the government.
Savers will be able to make contributions and receive a bonus from the age of 18 up to the age of 50. So someone could, in theory, end up with £32,000 worth of bonuses, assuming they were fortunate enough to be able to pay in the maximum £128,000 over 32 years.
2. You could end up with a pretty decent retirement pot
The government cash is the equivalent of a 25% interest rate on your savings. You’ll also get interest/investment growth on top of that, and the tax treatment is favourable – after your 60th birthday you can take out all the savings tax-free, whereas most pension schemes only let you take 25% of your pension pot tax-free.
Legal & General Investment Management says that if a 25-year-old took out a lifetime Isa and paid in £4,000 a year – which would then have £1,000 a year added to it by the government – they could end up with a tax-free pot worth more than £416,000 at the age of 60, assuming the fund enjoys annual growth of 5%.
3. For many, this will be better than a personal pension
“Opting for Isas over pensions has been the default choice for the younger generation, given that the former can be accessed long before retirement. The lifetime Isa will now make this choice a no-brainer, at least for aspiring property buyers,” says Ian Lowes at Lowes Financial Management. It’s a particularly good deal for self-employed people who don’t benefit from employer contributions into a workplace pension. Many self-employed people have no private pension, so the lifetime Isa is a good option for them. But if you’re not self-employed, watch out (see below).
4. It’s good news for parents and grandparents with spare cash
The lifetime Isa will be welcomed by people who want to help their offspring in a tax-efficient way, says Ian Dyall at financial planner Towry. “The inheritance tax annual allowance is £3,000 per person per year. A couple could therefore give their child or grandchild £2,000 each (because the Isa cap is £4,000) to put into the lifetime Isa, and this would not be subject to inheritance tax.This is already possible with a pension, but the saver is not able to access the money.”
Why you shouldn’t
1. The best way to save for retirement will still be via a workplace pension
Steven Cameron at Aegon was one of many experts who said there was a huge risk that the new accounts would discourage some under-40s from joining their workplace pension scheme, even though that comes not only with tax relief from the government, but also with a valuable employer contribution. AXA Life Invest says: “A good old pension is still the most tax-efficient way to save, and this will continue to be the case for under-40s even after the introduction of a lifetime Isa.”
2. It won’t suit some would-be homebuyers
Your lifetime Isa cash can only be put towards the cost of a first home worth up to £450,000. So if you already own a home this is no good for you. And that £450,000 cap could prove problematic if house prices continue to rise or you are buying in a pricey area. Any withdrawals by those under 60 that aren’t for a first home will lose the government bonuses (plus interest/growth) and be hit with a 5% penalty.