Consider the following question. In respect of a millennial employee (aged under 40, aka “Generation Y”), what does a pension pot offer that a Lifetime ISA (LISA) does not? The LISA trumps pension pots in three fundamental respects.
1. Pre-retirement access: a free option.
When buying the first home, LISA savings (including the 25% bonuses) can be accessed at any time without penalty. Numerous surveys evidence that the under-40s prioritise saving for their first home over contributing to a pension. Given that the upfront incentives paid on LISA and pension pot contributions are economically identical for basic rate taxpayers, i.e. some 92% of all workers under 40, this pre-retirement access to LISA savings is effectively a free option for the saver (1).
2. Post-retirement access: tax free.
From the age of 60, LISA savings can be withdrawn tax-free, whereas capital withdrawn from a pension pot is taxable at the saver’s marginal rate. Thus, if the LISA is held until 60, its tax treatment for basic rate taxpayers is effectively entirely tax free. Pension pots’ 25% tax-free lump sum does not compensate for this: the other 75% is still taxable.
3. LISA bonuses: major advantages for the low-paid
The LISA provides other significant advantages over a pension pot because its 25% bonus is disconnected from the employees’ tax-paying status. Unlike pensions’ tax relief, bonuses are paid even if total earnings (from one or multiple jobs) fall below the Personal Allowance. In addition, bonuses overcome the “net pay” debacle, whereby those earning between the auto-enrolment trigger of £10,000 and the Personal Allowance make gross contributions but do not receive any tax relief. This currently disadvantages some 280,000 workers, but once the Personal Allowance rises to £12,500 (April 2019) some 500,000 workers are expected to be affected.
Clearly, LISA bonuses make far more sense to low earning (part time) employees, predominately women, when the alternative may be no pensions’ tax relief. And they should particularly appeal to companies keen to be seen promoting gender equality.
In addition, the widespread distrust of the pensions industry is often cited as a deterrent, whereas the ISA brand is still reasonable trusted. That said, pension pots do hold some advantages over a LISA, but none of them are material to the typical employee. Yes, higher rate taxpayers would be economically better off with a pension pot, but they are a small minority of the under 40 workforce. But for some of them, even the lure of 40% tax relief is insufficient to overcome pension products’ inflexibility, there being no access to contributions until 55 (57 from 2028). And there is the very real prospect that higher rate tax relief will disappear within the next few years.
Pension pots are sheltered from inheritance tax, whereas ISAs are not. But how many people in their 20s and 30s are worrying about paying IHT? This pension pots' advantage is a red herring in terms of influencing savings behaviour. Similarly benefits calculations. Pension assets are excluded, whereas ISA assets are not, but is this really a serious consideration for employees?
Personalisation is key
For most under 40s, the LISA is the most relevant and tax efficient vehicle within which to save. It is also offers the prospect of boosting employee engagement with saving: ISAs have their owners’ names on them, which engenders a sense of personal ownership. People refer to “my ISA” but they de-personalise their membership of “the company scheme”. An extraordinary 39% of auto-enrolled scheme members are unaware that they were a member of a workplace pension scheme. 95% had never tried to change their fund, 91% did not know where their funds were invested, 80% did not know how much was in their pension pot and 34% did not know who their pension provider was. Very few have identified a beneficiary, should they die. Personalisation is a prerequisite for engagement.
Ideally, savings derived through work should be as personal as a bank account, unencumbered by the jargon and paraphernalia of pensions. Being in control is closely allied to being motived, and therefore engaged.
Implications for workplace saving
Employers have long complained that their pension contributions are undervalued by employees, and therefore represent poor value for shareholders. Employees should be offered an alternative, that of having their employers’ contributions paid into a Workplace ISA. For the under 40s, this could be in the form of a Lifetime ISA, provided through the workplace. It has the potential to help catalyse much greater engagement with saving and could be cheaply delivered through the new breed of digital wealth platforms (“robo-investing”) which are accessible and convenient to use.
The 25% bonus paid on LISA contributions (made with post-tax income) effectively grosses up the contributions for basic rate taxpayers, akin to tax relief (1). An £80 contribution (from gross income of £100 less £20 tax) plus a £20 bonus (as 25% x £80) takes the total amount saved in the LISA to £100.
(1) Survey size: 938 auto-enrolled scheme members (Decision Technology, 2017)