The Chancellor unveiled a new savings account called the Lifetime ISA in his 2016 Budget. We look at what they are and you can benefit from them.
In the 2016/17 tax year, any adult can save up to £15,240 into an ISA.From April 2017, the allowance will increase to £20,000.
Contributions can be put into cash, shares, investment funds or a mix. However, Cash ISAs are a less attractive proposition due to a combination of low interest rates and the new Personal Savings Allowance that comes into effect in April 2016.
The new allowance means the first £1,000 of interest on all cash savings is free of tax for basic-rate taxpayers. That means a basic rate taxpayer could have £100,000 in the bank earning 1% before they started to pay interest. Even 40% taxpayers, who get a reduced £500 savings limit, could have £50,000 worth of savings.
How ISA taxation works
Contributions to ISAs are made from your taxed income, but savers can make tax-free withdrawals whenever they wish. It is the exact opposite of pensions, where contributions are made from gross pay (before tax), with withdrawals from age 55 being taxed – after the right to 25% tax-free cash.
The Lifetime ISA is designed to help first-time buyers and the self-employed to save for a pension. Although a workplace pension is still the most tax-efficient way to save.
It sits between a traditional ISA and a pension. Contributions come from your taxed income and the Government gives you a bonus if you keep your savings in until you use the money for a deposit on a first time home or turn 60.
For every £4 a lifetime ISA investor contributes, the Government will put in an additional £1.
Who qualifies for a Lifetime ISA
The new ISA will be available from April 2017 if you are under the age of 40.
You will be allowed to contribute a maximum £4,000 a tax year – with the Government topping up this amount by up to £1,000 a year until the plan holder hits age 50 when no more bonuses will be paid.
You will still able to put aside up to £16,000 into a conventional ISA too.
The Chancellor designed the savings plan for first time buyers and saving for retirement. So unlike standard ISAs that allow you to access money at any time without penalty, the Lifetime ISA comes with penalties if you withdraw early.
A 5% exit charge will be levied on any withdrawals made before age 60 – and not used to buy a first home – the Government will take away some of the bonus it has put into your Lifetime ISA account and any subsequent investment growth that bonus money has enjoyed.
So is a Lifetime ISA worth it?
The government bonus is the equivalent of a 25% interest rate on your savings. That’s incredible given current interest rates. You can also achieve interest and investment growth on top of that.
The tax treatment is beneficial too. Most pension schemes only let you take 25% of your pension pot tax-free, the Lifetime ISA enables you to take all of your savings tax-free after your 60th birthday.
Legal & General Investment Management estimates that a 25-year-old paying the maximum allowance of £4,000 a year into the new ISA could end up with a tax free retirement pot at 60 worth around £416,000. This is based on £1,000 added a year by the government and assuming 5% annual fund growth.
Is it better than a pension scheme?
Choosing ISAs over pensions can be a good choice if you are a younger saver, because it can be accessed before your retirement. The Lifetime ISA makes this choice easier, especially if you are saving to buy your first home.
It is a good option if your are self-employed too, as you won’t be receiving contributions into a workplace pension.
A pension is still the most tax-efficient way to save for retirement, even for under 40’s, as they come with tax relief on your contributions from the government and employer contributions.
Who should steer clear of the Lifetime ISA?
Lifetime ISAs cash cannot be put towards buying a home if you already own one, its for first time buyers. If you think you will need your cash before you are 60 other than to buy your first home, you will lose the government bonuses, plus interest and growth on your savings and be hit with the 5% penalty.
Who could benefit most?
It’s good news if you are a parent and want to help your children in a tax efficient way. You could put the equivalent of your Inheritance Tax annual allowance into the lifetime ISA and this would not be subject to inheritance tax. You can do this now with a pension, but your child can’t access the money except when they retire.