There were three standout announcements in the 2016 Budget:
- The doubling of the rateable value eligible for Small Business Rate Relief that will exempt hundreds of thousands of retail stores and offices from Business Rates;
- The introduction of a Soft Drinks Industry Levy on sugary drinks as a hypothecated tax to pay for school sport;
- and the Lifetime ISA.
This article looks at the Lifetime ISA, how it will work and whether it could be start of the road to pension reform.
Lifetime ISA accounts will be available from April 2017 for individuals aged between 18 and 40 who will be able to invest up to £4,000 each year up to the age of 50. The government will contribute an annual bonus of 25% of the amount invested.
An eighteen year-old would be able to have contributions of £128,000 matched by the government maximum bonus of £32,000.
However, the Lifetime ISA is for two specific purposes:
- the deposit on the purchase of a first home worth up to £450,000 nationwide;
- or as savings for retirement where all the savings can be withdrawn tax-free after the individual’s 60th birthday.
Whilst the funds can be accessed for other purposes before the individual’s 60th birthday, the government bonus on this amount together with any interest or growth on this will be lost. In addition, a 5% surcharge would be payable.
For example, if £20,000 of contributions had been made topped up by £5,000 from the government and the ISA had grown in value to £30,000 and the money needed to be retrieved for an unforeseen circumstance, the individual would actually receive £23,750.
On the other hand, the Lifetime ISA offers a tax-efficient method for parents or other relatives to help their heirs. Under current Inheritance Tax rules, the Annual Exemption is £3,000 per donor per year. Therefore, relatives could join together to fund the contributions without these incurring Inheritance Tax.
For those looking to save to save to buy their first home, the Lifetime ISA is extremely attractive. The Lifetime ISA per person not per home, so a couple would each receive a bonus when buying together assuming that it is the first home for them both.
Help to Buy ISAs will be either transferable into the Lifetime ISA or can to be invested in alongside but bear in mind that the bonus from only one scheme can be used in the purchase of the property.
The only concern is there is no indexation of the £450,000 ceiling on the property price and, with annual average property inflation running at 4.8% overall and more than 12.0% in London and part of the South East, this could need to be addressed.
For those looking to save for retirement, the situation is more complex.
Certainly, for the self-employed who are excluded from workplace pension schemes, the Lifetime ISA is a sensible route especially for the high proportion without a private pension.
However, those making contributions to a workplace pension are receiving an equivalent tax relief from the government plus the employer contribution.
On the current minimum contribution ratios, every £8 that the employee pays is topped up by £2 tax relief from the government and £10 from the employer. Ultimately in 2018, employer contribution will reduce to £6 but there will still be overall matched funding to the contribution.
Similarly, standard rate tax payers paying into a private pension scheme are receiving an equivalent tax relief to the Lifetime ISA government contribution. Indeed, higher rate tax payers are receiving substantially more – £2 for every £3 contributed.
This has led many in the pension industry to view the Lifetime ISA as a Trojan Horse on the road to the reform of pension tax relief.
For those with sufficient disposable income, the Lifetime ISA is an option to build a bigger retirement fund in conjunction with their existing pension arrangements.
If you would like to discuss efficient tax planning, the Lifetime ISA or any other aspect of Budget 2016, please email us at email@example.com.