It’s been heralded as an innovative new way to help first-time homebuyers on to the property ladder and plug the pensions gap. Two of the biggest problems UK adults under 40 face today. Amazing. But tread carefully. The Lifetime ISA, which is available from April 6, 2017, is not all it’s cracked up to be.
Another brick in the wall
The government loves a gimmick. It particularly loves a gimmick in the shape and form of an ISA – the Individual Savings Account that gives you tax breaks.
At the turn of the century we had the Mini ISA and the Maxi ISA, later renamed to the Cash ISA and the Stocks & Shares ISA. You can save (in to a Cash ISA) or invest (in to a Stocks & Shares ISA) a certain amount each year (up to £20,000 for the tax year 2017-18) and, for the whole time you keep the money in your ISA, it’s free of capital gains tax.
Then we had the Help To Buy ISA, where you can get a 25% top-up on your savings to help you build up a deposit for your first home. We’ve also had the Junior ISA – effectively a mini Cash ISA you can open for your kids – and last year came the Innovative Finance ISA, which covers investments in peer-to-peer lending platforms, and the Flexible ISA, which is really just a set of optional add-on features surrounding transfers and withdrawals.
Got all that? Good. So let’s tell you a little more about the latest ISA off the government’s conveyor belt. The Lifetime ISA.
An ISA is for life. Or is it?
If you’re under 40 you can open a Lifetime ISA and pay in up to £4,000 a year up until your 50th birthday. The government will add an annual bonus of 25% to any amount you put in. So, for every £4,000 you save, the government will add £1,000.
You can then use these savings to buy your first home , up to the value of £450,000, or keep it in savings until you turn 60. For both options, you can withdraw your money, including the 25% government bonus, tax-free.
Sounds simple. Sounds great. And for some people it is. But don’t run to open your Lifetime ISA just yet. The terms and conditions, when examined closely, show that it is not great – or simple – for everyone.
If you need to access your money before you are 60 for any reason other than to buy your first home (costing less than £450,000) or because of terminal illness, you will pay a hefty penalty. Not only will the government reclaim the 25% bonus and any savings or investment growth on that bonus amount, it will also charge an additional 5% of the total value. So you could ed up with less than you put in.
Compared to a pension, the Lifetime ISA is treated differently for tax purposes. Some taxpayers may be better off contributing to a pension. If you choose to opt out of your workplace pension to pay into a Lifetime ISA, you will lose the benefits of the employer-matched contributions.
Oh, and you can’t buy a property and then rent it out – you must live in it. And it must be in the UK. If you already have a Help To Buy ISA you can transfer it to the Lifetime ISA or save into both, but you will only be able to use the bonus from one of them to buy your first property.
Two words. Devil and Detail.
Capital-C Conservative marketing
The Lifetime ISA is good for some but it is not the golden bullet. It is actually another headline-grabbing savings initiative, sneakily and strategically linked to two hot topics for millennials – housing and pensions – that has a lot less substance than the Chancellor would have you believe, once you’ve kicked the tyres and absorbed all the small print.
For one, the name ‘Lifetime ISA’ is curious. Why choose to label it ‘Lifetime’? It doesn’t last your entire lifetime. Is this to make us feel like it’s even bigger and better than the previous ISAs? A magic cure to all our long sufferings? Perhaps I’m being overly cynical here, but it does have a strong whiff of clumsy marketing about it, like it hasn’t been given its full consideration and due diligence.
And herein lies the source to a long and growing history of ISA problems. ISAs have always been rushed out, part of the annual Budget statement by the Chancellor each March, when they’re invariably looking for a piece of good news to announce and project into the media, to detract from the negative news – usually tax hikes, or spending cuts. The ISA has become something of a saving grace for the government in this sense. It’s a cheap trick and an easy yet flimsy get-out-of-jail card.
The government is quick to hone in on the fact that ISAs give you generous tax breaks and ISAs are often advertised as ‘tax free’. Don’t be fooled. They’re not. You avoid capital gains tax on funds you hold in an ISA, yes, that’s true, but they’re not strictly speaking ‘tax free’. You may still have to pay tax on dividends, for example.
More importantly, we all have a separate tax allowance on capital gains from investments anyway – and from dividends! For the tax year 2017/18 those annual personal allowances – the amount you can earn before you have to pay any tax – are £11,500 on capital gains, £5,000 for share dividends and up to £1,000 on savings accounts. The vast majority of people won’t be making anywhere near £11,500 in capital gains on their ISAs in a single year. They’d need in the region of £100,000 or more in ISAs to have to worry about that. And if you’ve got that much, you’re unlikely to worry.
There are countless other ISA rules and regulations to baffle you too and they change every year. The annual ISA allowance itself has changed most years over the past 16. At one time you could only have a Cash ISA or a Stocks & Shares ISA but now you can have both. You can now transfer your ISAs but you can’t take a Stocks & Shares ISA into a Cash ISA. If you have a Help To Buy ISA that counts as your Cash ISA for that year. ISA allowances generally run for one year, except the Help To Buy ISA which runs over multiple years.
The list of technical details and restrictions designed to confuse goes on and on and on. And all the while, the most common Google search term related to ISAs is, by a long way, ‘What is an ISA?’
The learning zone
The government has a lot of work to do on financial education. They should be less focused on repackaging gimmicks and devote more continued effort to communicating good financial habits to the public in a real, meaningful and engaging way – while cleaning up the foggy rocky landscape of financial apparatus too, of course.
To be fair, there are a number of excellent industry working groups beavering away at this right now, looking at ways to simplify common money issues for UK adults and create rules and nudges that resonate to promote better financial planning. I know because I’ve been involved in some of these projects, albeit in a small way. But these projects are so stealthy and drawn out that they’re unlikely to ever see the light of day. By the time they’re done, the ISA will have skipped ahead several more steps, or we may even have a new government in place that wants to take an entirely different direction.
One world, one vision
So how do we sort out the ISA mess we have? I’m not saying it’s easy but there are obvious changes that could be made, all in the name of simplicity. For starters, we should have just one ISA. There’s no need to have all these different flavours. The ISA and the pension can also be moulded into one. It’s just an account, a savings account, and you should get your tax relief on whatever amount you put in up to an annual limit of £50,000. You should then be allowed to use it on whatever you like, whenever you like. It’s your money after all!
Next, scrap inheritance tax. Completely. The savvy savers use these products and criteria to squirrel away their wealth and protect it as best they can while the less literate (financially speaking) are left to the dogs.
There would be budgetary details that make all this complicated behind the scenes, I’m sure, and there’s no denying it would need careful thought, but that’s what the government is there for. Guys, don’t push such complications front of house and expect us, ‘the customer’, to understand your difficulties and deal with them on your behalf. That’s your job, mate!
But I fear we’ll never have that level of common sense or support. Certainly not in my ISA lifetime! So I leave you with a final word of warning on ISAs…
Do your homework. Sadly no one is going do it for you and, despite the government’s overtones, they’re not giving you a shiny new savings present on a plate with the Lifetime ISA. In fact, it could do you damage and you might not even know it until it’s too late. BUT, if it ticks all the boxes for you and you’re sure it’s not likely to ruin your pension pot elsewhere or tug at your tax liabilities later on, then go for it – take all the help you can get.