Lifetime ISA – Lovely Lisa ramps up Help-to-Buy bungs

The pensions industry had got itself into a right pre-Budget tizz as a result of carefully managed Treasury leaks suggesting the Chancellor was about to abolish the current system of pension tax reliefs. Any such move would be the ultimate administrative nightmare, since merging existing pension schemes with ones designed for the new regime would be all but impossible without either a vast government subsidy or a massive rip-off of taxpayers. This was never a serious proposition. But the speculation about this meant that the Chancellor’s Budget wheeze, the Lifetime ISA, was immediately categorised by pension nerds as a back-door start to replacing tax relief on pension contributions.

Fortunately for Osborne, this has meant that almost nobody has questioned the logic of the huge government bungs involved in Lifetime ISA, the vast majority of which will be used towards property purchase by moderately wealthy kids.

The current Help-to-Buy Isa gives a 25% bung on savings up to £12,000, making the maximum subsidy for home ownership £3,000. With Lisa, the maximum bung escalates to £32,000. You can invest £4,000 a year from age 18 to age 50 and collect £1,000 in subsidy each year. If you spend the entire sum in your Lisa account on a first home valued up to £450,000, you keep the bung. Likewise if you cash it in after age 60. Use it for any other purpose and you lose the bung and pay a penalty.

This is not, as some dim commentators have suggested, an alternative to pension savings for young people. Most young people will get matching contributions by their employer. If they put £1 into the pension scheme, the employer puts in £1. The employee’s contributions get tax relief, so for most it will cost 80p. That means the employee using the pension plan gets an investment of £2 for 80p. With Lisa, it is £1 for 80p. No contest. Even allowing for the fact that you can only take a quarter of the pension fund as tax-free cash, you will end up with far more capital or net income from the pension than from Lisa.

Lisa will, of course, be exploited by the wealthy for their children. I don’t know any 18-year-olds who can save £4,000 annually out of their earnings, but there are plenty of parents who will save that amount for their children’s first home. Unlike the normal ISA, the loving parent will have the comfort of knowing their child cannot access the cash for a wedding beano or a shiny new motorbike. Get planning now for the scheme launch in April 2017.

Gains tax cut will backfire

Most analysts at the Treasury know that if you have differential rates of tax on income and capital, money morphs into the form bearing the least tax. So the only predictable effect of the cut from 28% to 20% and 18% to 10% in gains tax rates for higher rate and basic rate taxpayers, effective from 6 April 2016, is that it will result in financial engineering to benefit the wealthy. I expect by the autumn we will see schemes which transform income taxable at 40% into gains taxable at 10%.

The change might have one good effect, though, which is that Trustees, who have historically been reluctant to take profits and pay CGT, may feel they can now adjust trust portfolios to better meet beneficiaries’ needs.

ISA for more

The annual ISA allowance remains the same at £15,240 for 2016-17, but the following year it leaps to £20,000, a level you should probably expect it to remain at for some years to come. The Lifetime ISA falls within this allowance.

Given that for wealthy people, keeping capital untouched in pension funds is the best way of getting cash to the next generation free of inheritance tax, there’s a strong case for getting as much of your other capital as you can into ISAs so that you can draw as much of your retirement income as you can from this source. And the extra 7.5% tax on dividends is also an incentive to do this.

Dividend tax ahead

The extra 7.5% tax on dividends in excess of an annual £5,000 dividend allowance, announced in the 2015 Budget, takes effect from April 2016.

Apart from private company owners who are paying themselves through dividends, the losers from this tax hike should be able to avoid at least some of the effects by progressively switching capital into pension funds or ISAs. Income from these sources does not count towards the allowance. And transfers between spouses can also be used to avoid breaching the limit.

Simpler with the PSA

The Personal Savings Allowance is that rare beast, a genuine tax simplification measure. From April 2016, interest from deposits up to £1,000 per year for basic rate taxpayers is exempt from tax (£500 for higher rate taxpayers). At current interest rates, over 90% of savers will pay no tax.

From April 2016, banks will pay interest without (as they have done previously) deducting tax at source.
Savers will need to review their Cash ISAs–- many thousands of savers have accumulated large cash piles. Interest rates on cash ISAs are lower than those on non-ISA accounts. You would need well over £50,000 on deposit at current rates to breach the £1,000 annual interest allowance.

Chris Gilchrist, April 2016