Following the triggering of Article 50, it looks set to be a momentous year in British politics. It will be a momentous year for Isa investors too, with a host of changes coming in that will make Britons’ favourite tax-free savings vehicle an even more powerful tool in any investor’s arsenal.
Most significantly, the amount you can contribute has today risen to a hefty £20,000. It’s worth remembering that in 2010-11 the respective figures for cash and stocks and shares Isas were just £5,100 and £10,200, and now you have total flexibility about where you can put your money (cash, stocks and shares, or any combination of the two).
The new, higher Isa allowance will be of particular relevance to top rate taxpayers, who have faced increasing constraints on the amount they can pay into their pensions. If you earn £150,000 or more a year, your pension annual allowance is cut by £1 for every £2 in extra income you receive, meaning that if you’re on £210,000 or over, you can contribute just £10,000 annually. The Isa may not attract the same up-front tax relief on contributions, but everything within it is free from tax, making it an excellent vehicle for long-term savings.
Today also sees the launch of the Lifetime Isa. This new product enables you to save up to £4,000 a year and receive a 25 per cent top-up from the government on your contributions, bringing the year’s total to a maximum of £5,000. You can hold one of these alongside traditional cash or stocks and shares Isa products, with the £4,000 coming out of your £20,000 allowance. Unlike a pension, all eligible withdrawals are free from tax.
There are two major restrictions: first, you must be between the ages of 18 and 40 when you open the Lifetime Isa, and once it’s open, you can only continue receiving the 25 per cent bonus until you’re 50; and, second, the money must be used either to buy your first home or for later-life savings after you’ve turned 60. You can take money out early for other purposes, but you’ll have to pay a 25 per cent penalty on withdrawals. The complication for Londoners is that you can only buy a house worth up to £450,000 with the money, well below average property prices in the capital.
It certainly has its attractions, and polling by Hymans Robertson has shown enthusiasm for the new product, with 61 per cent of under 40s saying they will open one. But only a few providers are currently set up to offer them, and there is some caution in the industry for two reasons.
First, it risks complicating the otherwise simple Isa. “The Lifetime Isa throws in numerous curveballs,” says Oliver Smith, portfolio manager at IG. “Penalties for early withdrawals, age limits, contribution caps and limits on the value of the house you can buy will increase the likelihood of savers making the wrong decision.”
Second, there is a worry that people will divert savings from pensions to the Lifetime Isa, when they would be better off not doing so. “On the face of it, the Lifetime Isa looks like a great product for saving for retirement, offering a big government bonus up-front and tax-free benefits when you retire,” says Richard Parkin, head of pensions policy at Fidelity International. “But compared to a workplace pension where your employer contributes, it falls a long way short.”
Read more: Lifetime Isa: The making of a monster
He adds that individuals should make sure they stay in their workplace pension and maximise any employer contribution before thinking about the Lifetime Isa for retirement saving. “Overall, we see the Lifetime Isa as being a useful product for those saving for their first home. But as far as retirement goes, it’s probably got more limited use as a mainstream product.”
Moreover, for certain taxpayers, the up-front tax relief on pension contributions (45 per cent for top-rate payers, 40 per cent for higher rate) will be more lucrative than the 25 per cent Lifetime Isa bonus.
Nevertheless, many experts are convinced that the Lifetime Isa is an embryonic form of the type of savings product the government would like to roll out in the future as a replacement for the pension. Some argue, for example, that the pension itself is tarnished, following hostile tax changes, governance scandals, and high profile failures of particular schemes. The Isa, in contrast, enjoys high levels of respect and trust among savers.
Equally, although up-front tax relief on pension contributions is not a true “cost” to the Treasury – as people must pay tax on pension withdrawals, it is more accurately deferred taxation – there is a debate about the fairness of those on higher incomes receiving relief of 40 or 45 per cent, especially if they only take an income from their pension sufficient to pay 20 per cent tax on withdrawals. The flat 25 per bonus on the Lifetime Isa is on the surface fairer, even if it currently only accrues to £4,000 of saving a year.
If the Isa is the future, what does it mean for how investors should use it? Simply put: certainly don’t abandon your pension, but make the most of the full suite of Isa products out there and the new £20,000 allowance.
The government has in recent years shown a willingness to make big changes to pension policy that have had the effect of penalising those who have put a lot into their pension. The pension lifetime allowance, for example, has been cut successively and now stands at £1m. If you have more than this in your pension, you will pay penal rates of taxation on the excess, and tens of thousands have been caught out by the change. There is no upper limit on what you can hold within your Isa.
Predicting what will happen next is no easy task, especially given that the government, busy with Brexit, appears to have rowed back from making major changes any time soon. But with continued pressure to find creative solutions to the likes of the later-life care crisis, involving people taking greater responsibility for themselves, it is next to certain that the Isa will be a central part of the government’s plans.