Budget 2016 – pensions, the Lifetime ISA, and the over 40s!
At 12.30pm on Wednesday George Osborne gave his Budget speech, and we discovered that the big news with regards to pensions…. was that there was no big news specifically about pensions! There were no changes to tax relief on contributions, no new announcements about annual or lifetime pension allowances, all discussed in my earlier post. In his own words: “Over the past year we’ve consulted widely on whether we should make compulsory changes to the pension tax system. But it was clear there is no consensus.”
What there was instead was a new alternative to pensions for the under 40s, the Lifestyle ISA, which seems to be a hybrid product combining elements of a pension with an ISA. If you’re over 40 like me, tough, you’re excluded and can’t join the Lifetime ISA club!
The pension-specific announcements
There were a couple of small pension-specific announcements:
- A pensions ‘dashboard’ will be launched by 2019. This is intended to make it easier for us to view information about our retirement savings in one place, and hopefully make more sense of multiple pensions we may have built up.
- Public sector employer contributions will rise from 2019-20.
There were also a couple of announcements about pensions and financial advice. The Treasury has had a busy week as, with the regulator, it launched on Monday the final report from the Financial Advice Market Review. There have been huge changes in the financial advice industry over the past few years, but as these announcements are not so much about pensions as about financial advice, it’s potentially an issue I’ll come back to another day. However, in summary:
- The government plans to amend the definition of regulated advice, clarifying the distinction between ‘advice’ and ‘guidance’, and making it easier for firms to offer guidance.
- If we’re under 55, we’ll potentially be able to take up to £500 tax free from our pension to pay for financial advice about our retirement.
Introducing the new Lifetime ISA
This was the ISA cat amongst the pension pigeons, a Lifetime ISA that is being launched next April. George Osborne acknowledged that people in their 20s and 30s often have no pension (he said they’re complicated and inflexible), don’t have enough savings, and cannot choose between saving for a home or retirement.
So enter the new ISA. It works exactly like any other ISA i.e. contributions are paid from income that has already been taxed, but the fund grows tax-free and you can take your money out tax-free. You can pay in a maximum of £4,000 a year (about £333 a month), and the government will top this up with a 25% bonus each year (up to the age of 50), which is £1,000 if you pay the maximum. You can use the money to pay for your first home, up to the value of £450,000, or you can keep the money invested and use it for retirement.
It seems to offer a very good alternative for retirement saving for the self-employed, and also for basic rate tax payers, compared to a pension, and an excellent product for saving to buy a home regardless of rate of tax you pay – where else can you get a 25% return on cash saving?
I’ve outlined some differences between the ISA and pensions below, but a key point is the ISA is only available to those aged 18-40. Once you have one you can continue paying in when you’re older, but you can’t take one out if you’re already over 40. So for me and this blog, which is looking at what you can do to address a retirement shortfall when you’re already half way there, it’s not much use!
ISA limit increased to £20,000
However, we can still pay into other types of ISAs, so the news that is relevant for us over 40s is that if you have extra money sloshing around you can now put more of it into another one of these tax-free wrappers. The total ISA limit is increasing to £20,000 a year from next April compared to £15,240 now.
Lifetime ISA vs Pension
George Osborne says that his pension reforms are about giving people more freedom and choice, but it can be confusing knowing which savings product to pick (again, possibly the area of financial advice is something to come back to!). The following is an initial comparison of the two products, and if you’re too old to take out a Lifestyle ISA, possibly might help to show if you’re missing out on anything!
- Bonus / tax relief – The 25% government bonus is identical to the tax relief you get with a pension if you’re a basic rate tax payer, though note the government only pays the bonus on the ISA until age 50, while you’d continue to get tax relief on pension contributions. Higher rate tax payers will get more tax relief with a pension – it would be the equivalent of £5,600 going into your pension compared to £5,000 going into your ISA if you were to pay £4,000 annual contribution. Also note that with basic rate tax payers, the bonus with the ISA will be paid at the end of the tax year, whereas tax relief is applied on each monthly pension contribution. This means with a pension you’ll start getting investment returns on the tax relief (read: government bonus) straight away, with the ISA you’ll have a bit longer to wait before you start getting compound growth on the bonus.
- Employer pension contributions – Only you can pay into your Lifestyle ISA, but if you have a workplace pension, you’ll also be receiving contributions from your employer, so you’ll have extra money going into your fund.
- Annual contribution limits – You can only pay £4,000 tax-free into an ISA. This is still quite a lot – £333 a month. However, if you do have extra money, you could get tax relief on more with a pension – up to your earnings or £40,000 a year.
- ISAs are more flexible – You can take out your funds any time you wish, and it’s tax-free when you buy your first home or from age 60. You can’t touch your pension until age 55, and then can only withdraw 25% tax-free. However, if you’re using your ISA for retirement, then the ability to withdraw your money earlier may be a disadvantage. If you spend the money before retirement, then you won’t have any left later in life. The government recognises this also, as you’ll be penalised by foregoing the bonus AND any investment growth on that bonus, along with a 5% charge, if you withdraw money from the Lifetime ISA other than for a home or after age 60.
So what does this all mean, especially if you’re over 40?
Well, if you’re too old for a Lifestyle ISA, then nothing has changed. Save whatever you can, as it’s not just 20- and 30- year olds who don’t have enough savings. I’ll be looking at how much we should be saving in coming weeks. If you’re saving for retirement, then pensions still seem to offer one of the best investment products on offer. If you’re saving for shorter-term objectives, then ISAs offer a great alternative. It’ll be interesting to see what impact the new ISA has on pension savings, also what changes the government may decide to make to pensions in future budgets. That lack of consensus George Osborne referred to doesn’t mean one won’t be reached, or changes imposed without one!