Steve Webb: Lifetime ISA means working until you drop

Steve Webb, the former pensions minister, may have been the butt of George Osborne's jokes during the Budget Speech, but he's not laughing now. Webb is worried that anyone who relies on a Lifetime ISA to save for their retirement may never be able to give up work.

The LISA sounds on the face of it to be a really useful scheme. It enables people to start saving from the age of 21. They can put up to £4,000 a year into a LISA, and the government will match that with another 25% - up to £1,000.

They will do this every year until you reach the age of 50 - which is a huge boost to savings. Once people reach the age of 60, they will be able to withdraw the money from their LISA tax-free, and use it to create a retirement income.

However, Royal London Director of Policy Steve Webb warned that there are a number of aspects of the new saving scheme that ring alarm bells among the experts - particularly if people use it to save for their future in place of a workplace pension.

The drawbacks

First is the structure of a product that has two different savings goals. Given that the current average age of a first-time buyer is 31, it's safe to assume that young people may start saying into the LISA in order to get enough cash together for the purchase of their first home. If they buy in their mid-30s, they may then empty their LISA, so they only start putting money aside for their retirement at that point.

Webb highlights a recent Royal London report, which found that those who do not start saving until their mid-30s could end up having to work into their 80s to get the sort of retirement that their parents enjoyed. He compares this to a workplace pension, where people are enrolled at the age of 22, and start saving for their retirement immediately.

Second, is the way the government bonus works. The government pays a bonus into your LISA every year until you reach the age of 50. At that point it stops, but you cannot get the money out for another ten years. With a workplace pension - by contrast - you get tax relief throughout the entire period you are saving, and you can get the cash out from the age of 55.

The biggest issue

One of the most striking differences, however, is that under the LISA there is no matching contribution from an employer. Webb points out that someone who chooses an ISA instead of a workplace pension could miss out on tens of thousands of pounds in employer contributions that they would receive if they stayed enrolled in a workplace pension.

Tom McPhail, Head of Retirement Policy at Hargreaves Lansdown, has done the maths, explaining: "With workplace pensions, any employer contribution is going to outweigh the benefit of the tax treatment of the LISA. For example, under the auto-enrolment statutory minimum contributions from 2018, an £800 employee contribution would receive £200 in tax relief, plus £600 of employer contribution. Even with income taxed at 20% in retirement, this £1,600 pension pot would produce a net return of £1,360." By contrast, the same investor putting the same sum in a LISA would get £1,000.

Tax issues

It's worth being aware of the limitations of the tax advantages of a LISA too. The average woman in retirement pays no income tax, in which case the promise of tax free withdrawals from an ISA is of no value. In this situation, beyond the age of fifty, the LISA offers no effective tax break. Meanwhile, a workplace pension offers up-front tax relief, boosting the value of the pension saving by 25% for a basic rate taxpayer.

For higher earners, meanwhile, not saving through a workplace pension means the loss of higher rate tax relief - which is not available with an ISA. Beyond fifty, the tax break on the ISA is only the equivalent of standard rate relief.

Who can benefit?

Webb admits there are some groups that could benefit from the LISA. McPhail agrees. He says that for those who aren't entitled to an employer pension contribution, it has definite advantages over a standard ISA, pointing out: "Every £800 paid in to the LISA will deliver £1,000 (plus investment growth) in their hands after 60. By comparison, a conventional ISA would return £800 and after tax, and a pension would deliver £850 (for someone paying basic rate tax in retirement)."

He adds that those who have already secured their maximum employer pension contribution through a workplace scheme, who want to save more on top, and who will be paying the same rate of tax in retirement as when they are working, will also benefit. He explains: "For these investors, the LISA could work well. By contrast, anyone paying a lower rate of tax in retirement than in work is likely to find that the higher upfront tax relief on a pension, coupled with the lower income tax on withdrawals, will make a pension more attractive."

What should you do?

All in all, Webb urges people to think long and hard before opting for a LISA over a workplace pension - so they are aware of everything they are giving up. He says: "There is a real danger that the new product will mean that many young people will not start pension saving for their retirement until their thirties or beyond and will struggle to make up for lost time. The price of helping young people to buy a house should not be that they have to work until they drop because of inadequate retirement saving."

If you are unsure what to do, McPhail advises: "Until April 2017, investors should make the most of the allowances available to them through the existing pension and ISA systems now, and deal with the next year when we get there. For most people most of the time, the pension system is still likely to offer a better deal for retirement saving, however there are specific categories of investor who may want to take advantage of the LISA from April 2017."