Whilst the lifetime ISA can be used to purchase a first home, it can also be a valuable tool for retirement planning. Darren Goodall of Informed Financial Planning explains how.
From April 2017, anyone can open a lifetime ISA if they are between 18 and 40 and use it to save for retirement. Any savings put into it before your 50th birthday will get a 25% bonus from the government. The maximum contribution, until you reach 50, is £4,000 a year. I expect this figure to increase in future as ISA allowances usually do. But the government stresses that it is not an alternative to a workplace pension, just another retirement savings option. My view is that it should sit alongside traditional pension plans and stocks and shares ISAs to offer greater diversity and flexibility.
But there are two things to note:
1. It is designed for use in retirement so withdrawals before you turn 60 carry a 5 per cent charge, you’ll lose the government bonus and the interest or growth would need to be repaid.
2. The rules could change before you reach 60. Future withdrawals may not stay tax free as they are now, for example. But on the other hand, the trend has always been for ISAs to become more flexible over time so I am optimistic they will be a good long term investment.
The lifetime ISA is ideal if you don’t get the benefit of a workplace pension. It also works well if you have used your tax free annual allowance of £40,000 for pension contributions and want to top up with another 10 per cent tax free.
If you are in a workplace pension, your employer will contribute at least 3 per cent of your salary by 2019 under auto-enrolment rules. You should not opt out to pay into a lifetime ISA instead as you will lose contributions from your employer as well as tax relief, which is particularly valuable if you are a higher rate tax payer. This could have a dramatic impact on your retirement fund. Furthermore, a pension allows you to access your money at age 55 rather than have to wait until you turn 60 as with the ISA. If you are made redundant, your pension pot does not affect your entitlement to state benefits, whereas an ISA counts towards savings, which could do so.
Clearly, the best option, if affordable, is to contribute to a suitable pension and lifetime ISA as well.
But how to do this in the best way?
I advise anyone in a workplace scheme to FIRST make the necessary payments to their pension. This will ensure that their employer will make the highest possible additional contribution under auto-enrolment rules. With auto-enrolment, the minimum contributions are:
Employee net contribution Employer contribution:
Until April 2018 0.8 per cent 1 per cent
April 2018-April 2019 2.4 per cent 2 per cent
April 2019 onwards 4 per cent 3 per cent
This is a valuable tax free top up and many employers contribute more than this. But in order to afford your employee contribution, it might mean you have to adjust your lifetime ISA contributions.
What kind of ISA should you choose? There are cash or stocks and shares ISAs, both of which have their merits. Cash ISA returns have been hit by low interest rates, but are low risk. Stocks and shares ISAs don’t necessarily have to be high risk if balanced across a range of funds and sectors, but volatility would still exist.
Lifetime ISAs are a minimum 20-year investment and such a timeframe usually leads to at least some element of risk being taken, ironing out short term volatility to achieve long term gains.
Which ISAs? I recommend starting with a well-established provider that actively manages and rebalances funds. The key to success with the lifetime ISA is diversity, proactive management and a portfolio that matches an individual’s personal risk profile.