A chance of a lifetime for young savers?
- 15 Oct 2017
With its new Lifetime ISA, the government is providing a financial incentive in the hope of getting young people hooked on the savings habit. Sounds like an opportunity not to be missed? Well, yes and no. Ewan Pitcairn, head of Close Brothers adviser services, answers our clients’ most frequently asked questions about the new government giveaway for those under 40.
Q: What is a Lifetime ISA?
A: The Lifetime ISA is a new savings vehicle, which was launched by the government in June 2017. If you (or your children or grandchildren) are over 18 and under 40, the Lifetime ISA is worth knowing about. Open a Lifetime ISA and you could get a free government pay out of up to £32,000.
It allows you to save up to £4,000 every year until you are 50. For every £4 you save, the government will give you a £1 bonus.
To claim the bonus, you will either need to use the money to buy your first home, or wait to withdraw your savings when you are over 60. Pay in the total allowance for the full 32 years (between 18 and 50) and you could amass £128,000 (before any interest or growth) plus £32,000 from the government bonus.
Q: Is saving into a pension or a Lifetime ISA better?
A: In most circumstances, a pension will provide a better way of saving for retirement than a Lifetime ISA. This is particularly true if you have the opportunity to join a workplace pension scheme. If so, not taking your employer up on that opportunity is financial madness.
Not only do you get tax relief with a workplace pension, but also a contribution from your employer. If you are sacrificing some of your salary to pay into the scheme, you will also pay less national insurance.
Another consideration is your current tax rate. If you are a top-rate tax payer, the 40 per cent or 45 per cent tax relief on pension contributions means saving into a pension is still your best option for long-term savings.
However, if you are a basic-rate tax payer, the Lifetime ISA could be an attractive option, because the 25 per cent government bonus is equivalent to the tax relief you will receive on a personal pension contribution.
You should also consider what your retirement is likely to look like. With a pension, you receive tax relief upfront, but pay tax when taking the money out. With the Lifetime ISA, you get tax free withdrawals, but no immediate tax benefit.
Finally, think about how long you are willing to lock your money away for. You cannot take money out of a pension until you are at least 55. With a Lifetime ISA, you can access your cash at any time – although you will lose your government bonus and pay a five per cent penalty.
Q: Should my children use the Lifetime ISA for retirement or a deposit on their first house?
A: If they are actively saving for a deposit on their first house, the Lifetime ISA is a very attractive option. When it comes to retirement planning, it depends on their circumstances – for example, whether they are part of a workplace pension scheme or not.
It also depends on whether they are fortunate enough, even at such a young age, to hit the annual allowance each year for tax relief on pension savings (£40,000 for most people and down to £10,000 for the very well paid). If, after saving the maximum into a pension, they still have money to put away, then they may want to save into a Lifetime ISA as well.
Q: What is best – a Help to Buy ISA or a Lifetime ISA?
A: As with the Lifetime ISA, the government will top up a person’s savings by 25 per cent when they save with a Help to Buy ISA. However, with the Help to Buy ISA it is only possible to save up to £12,000, with a maximum government bonus of £3,000.
On balance, the Lifetime ISA is likely to be the best option in most people’s circumstances. Not only can you save more into a Lifetime ISA, but it is more flexible than the Help to Buy ISA. With the Lifetime ISA, you can invest as well as save, which is useful for those wanting to take on more risk.
That said, if there is a strong chance you will need to raid your savings early, you would be better off considering the Help to Buy ISA.
With this option, you lose the government bonus if you do not use the money to buy your first home, but there is no other penalty. If you withdraw savings from a Lifetime ISA before you hit 60 for a purpose other than buying your first home, you will forfeit your government bonus and any growth on that bonus, as well as receiving a five per cent penalty.
While this explains the differences between the Help to Buy ISA and the Lifetime ISA, it’s important to remember that the best option for you depends on your individual circumstances, needs and objectives. If you’re interested in opening an ISA or reviewing your options, please speak to your financial planner.
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