For the 90 per cent-plus of millennials who will be basic rate taxpayers while working and in retirement, the Lifetime Isa will produce a larger retirement income than a pension pot. So advisers that recommend pension instead of Lisa are arguably guilty of misselling.
Although Lisa and pension pot up-front incentives are economically equivalent, Lisa withdrawals are entirely tax-free, whereas 75 per cent of those from pension pots are not. Perhaps more surprisingly, the Lisa’s tax- advantage is also true in respect of those who will pay 40 per cent income tax while working and in retirement, albeit a very small population.
The only millennials for whom pension pots are the better vehicle from a tax perspective are those who will pay 40 per cent tax when working and then 20 per cent tax in retirement. This does not, however, take into account that most millennials have yet to purchase their first home, and at least some of them attribute substantial value to the Lisa’s penalty-free access for that purpose.
In 2020, some 50 per cent of UK workers will be millennials, rising to nearly 75 per cent by 2025, but few workplace benefits packages are designed to take this dramatic change into account. Most millennials’ best interests would be served through the inclusion of a workplace Isa in their benefits package, in the form of a Lifetime Isa.
But Lisas and pensions products are not mutually exclusive, and could be complementary. Some millennials may also like pension pots’ inaccessibility – savings are out of reach until at least 57. Accumulating savings in both vehicles would then make sense. Salary sacrifice considerations may also play a role in opting for multiple savings vehicles.
Both the Lisa’s 25 per cent bonus and pensions’ 20 per cent tax relief effectively reimburse the saver for any basic rate Income Tax paid prior to saving. However, when it comes to using the savings, Lisa withdrawals are tax-free from 60, whereas any form of income derived from a pension pot is taxable at the saver’s marginal rate, once the 25 per cent tax-free lump sum is taken into account. Perhaps more surprisingly, higher rate taxpayers (while working and then in retirement) would also be better off with a Lifetime Isa than a pension savings vehicle.
The post-tax contribution required to receive a post-tax £100 in retirement vary significantly – as follows. For a simple Isa, a £100 post-tax contribution is required, falling to £80 for the Lifetime Isa. It also costs £80 for someone who is a 20 per cent taxpayer when contributing, who is paying no tax in retirement. But for someone paying 20 per cent tax both in work and in retirement, the cost is £94.10, while it is £85.70 for someone paying 40 per cent tax in work and 20 per cent in retirement. Pension is only cheaper for the worker paying 40 per cent tax in work and 20 per cent in retirement, when it costs £70.60 to receive a post-tax £100 in retirement.
For over 90 per cent of the under-40s population, the Lisa is a more tax-efficient retirement savings vehicle than a pensions pot. For basic rate taxpayers, Lisa savings accessed from 60 are effectively entirely tax-free whereas the effective tax rate on a pensions pot is 15 per cent. And the Lisa’s first home purchase early- access optionality provides additional value.
The UK’s workforce is approaching a period of dramatic change in composition, and this will occur over a remarkably short timeframe. In 2020 some 50 per cent of our workers will comprise millennials, but by 2025 this will be nearly 75 per cent.
It is striking how people refer to “my Isa”, but when talking about workplace saving they de-personalise their membership of “the company scheme”. An extraordinary 39 per cent of auto- enrolled scheme members are unaware that they were a member of a workplace pension scheme, research has shown.
Employers have long complained that their pension contributions are undervalued by employees, and therefore represent poor value for shareholders. There are reasons for this, notably millennials’ dislike of pension products’ complexity and inflexible access, and their distrust of the pensions industry. Given this, it is in employers’ interests to offer their millennial employees a choice of workplace benefits that includes a Lifetime Isa. This could be presented as a Workplace Isa bearing the employee’s name, which would help engender a sense of personal ownership, and thereby help to boost employee engagement with saving.