On the lookout for LISA

Will next year's Lifetime ISA be a real pension alternative?

The rumour machine that operates before each year's Budget went into overdrive in 2016. First there was a steady flow of stories about changes to pensions that would see flat rate tax relief replace full income tax relief on pension contributions. Then, shortly before the Budget, there was a widely covered unofficial statement that the Chancellor had decided to make no changes. As it turned out, both rumours had an element of truth.

The good news is that full tax relief on pension contributions remains available for now, but Mr Osborne did not completely abandon tax reform of retirement savings. In a surprise move he announced the launch of the Lifetime ISA (LISA) from April 2017, which will only be available to the under-40s.

How LISA will work

The LISA will give investors a 25% government bonus on their contributions, up to an annual maximum of £1,000 (this being the amount of bonus payable on the maximum investor contribution of £4,000 a year). That's the equivalent of 20% basic rate tax relief. No bonus will be paid once an investor has reached age 50.

Provided the LISA has been held for a minimum of 12 months, the investor can use the funds to buy a first home, or withdraw them from age 60 and use the funds towards retirement or for any other purpose. As with existing ISAs, LISA investments will be free of UK tax and all withdrawals will be tax free, but the LISA bonus is lost and a 5% charge will apply if the funds are withdrawn before age 60 and not used for first house purchase.

Many commentators made the observation that the new LISA looked remarkably similar to ideas for a Pension ISA which were was floated by the Treasury last year. Some also saw LISA as a stalking horse for pension tax reform. It is not beyond the realms of possibility to imagine the LISA being made available to all investors in some future Budget, and tax relief on pension contributions being replaced by the LISA's 25% bonus.

In other words, the survival of higher rate relief may have been just a stay of execution.

The value of tax reliefs depends on your individual circumstances. Tax laws can change. The Financial Conduct Authority does not regulate tax advice. The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.