LISA0095

Written evidence submitted by Michael Johnson

Background

I proposed a Lifetime ISA (LISA) in 2014, detailed in a published policy paper[1], and George Osborne subsequently introduced one in his 2016 Budget. 

Unfortunately, the structural simplicity of the LISA that I proposed was compromised for reasons opaque; it was launched with some structural features that I did not propose, none of which are in the consumer interest.  These include an implicit 6.25% penalty on early withdrawals unrelated to a home purchase, a house price cap and some age-related restrictions. Consequently, it does not live up to its name.  I called it a “lifetime” ISA for good reason, intending it to be available from birth to death to encourage saving from an early age, not least to harness the positive power of compounding over many years. 

Today’s LISA also excludes a key behavioural lure: cost-neutral withdrawal flexibility (discussed below).  I also proposed a £500 starter bonus as per Child Trust Funds (again, not implemented). 

The result is a more complex product than the one I envisaged.  Since its launch, I have written several papers[2] and ministerial letters proposing changes to the LISA, so I welcome your inquiry, which will hopefully lead to some significant improvements to it….ideally returning to the simple, flexible form originally proposed.

This submission: two parts 

Part I proffers answers to some of the Committee’s ten specific questions; these are referenced in the text (as TSC question X) and include some proposals as to how the LISA could be enhanced in a manner beyond contemporary thinking (ref. your question 10). 

Part II provides some insights into what the LISA is capable of delivering, compared to a conventional personal pension savings vehicle (such as a SIPP).  It evidences that for those who end up paying a marginal rate of Income Tax at the basic rate of 20%, when working and in retirement, a LISA has a 17.6% advantage, as measured by the post-tax amount available at retirement.  This is an unambiguous fact, not subjective opinion, pertinent to most people (including 90% of the under-40s).  The LISA’s advantage arises through differences in tax treatment. 

In addition, for those who aspire to own their first home, the LISA provides a valuable free option; early penalty-free access.  Pensions products cannot compete with this.

This submission is written from the perspective of someone who has no commercial interest in the LISA, nor any part of the financial services industry. 

Proposals

Proposal 1:              The pre-60 withdrawal charge should be reduced from 25% to 20%, making for fully flexible, penalty-free access to LISA savings (ref. TSC question 6).

Proposal 2:  The LISA should be allowed to live up to its name.  It should be available from birth (perhaps through automatic enrolment at name registration), seeded with a £500 starter bonus, no access until 18, and a ten year “lock up” on contributions (and allied bonuses) made from the age of 50.

Proposal 3:  The LISA’s house price cap should be scrapped (ref. TSC question 8).

Proposal 4:  The LISA’s annual contribution limit should be doubled to £8,000, reflecting the last decade’s house price inflation for first time buyers (ref. TSC question 9).

Proposal 5:  The LISA should be included within automatic enrolment’s legislative framework as a “qualifying scheme”, eligible to receive employee contributions.  Employer contributions could be made into a Workplace ISA, attracting a 25% bonus and benefitting from tax-free access from the age of 60.

Proposal 6:  The self-employed should be auto-enrolled into a LISA with a 2% NICs-band-based, bonus-eligible, tax-deductible contribution.  Opting out would result in a 2% rise in Class 4 NICs (ref. TSC question 7).

PART I

1.              The LISA’s origins

1.1              A savings product aligned with motivation

A LISA was first proposed in response to a environment in which a rising number of millennials[3], in particular, were prioritising saving for their first home over saving for retirement.  Home ownership rates amongst the young have plummeted since 2000; today only some 43% of the under-35’s owned their home, whereas 59% did in 2000.[4]  In addition, the average age of first-time homebuyers has increased by three years over that period, from 29 years to 32 years (and 35 in London). 

Conversely, pension contributions are not considered to be among even the top three financial priorities until individuals reach their fifties.[5]  The prospect of locking savings away in a pension pot until at least the age of 57 is anathema; lack of access is increasingly being viewed as too high a price to pay in return for Income Tax relief on contributions.[6] 

The LISA was designed as a long-term savings product that overcomes this motivational dilemma, incorporating both pension-like and ISA-like features; a savings chameleon. 

Leaving savings in a LISA until the age of 60 is akin to having a pension pot, the 25% bonus being economically equivalent to tax relief at the basic rate of 20%.....with the added benefit of post-60 withdrawals being tax-free.[7] 

The alternative, of making use of penalty-free access to buy the first home, is ISA-like.  This is akin to a “free option”, of substantial value to many people, an option with which pension pots cannot compete.

Savers are able to choose how they use their LISAs: this flexibility is key and, crucially, the saver is in control.  Being in control is closely allied to being motived, and therefore engaged with saving.

1.2              A catalyst to encourage saving

The second objective for the LISA is that it should encourage people to start saving, comfortable in the knowledge that a change of mind (perhaps to spend rather than save) would not incur a penalty.[8]  Such an arrangement would encourage more people to save more, for longer, not least because we know that savings are “sticky”.  Witness, for example, the very low rate of opt outs from automatic enrolment’s embrace.  Inertia is powerful.

Consequently what was actually proposed was a 25% bonus and a 20% charge on any pre-60 withdrawal made for reasons other than the purchase of the first home.  These are economically identical, so reversing a decision to save would be penalty-free.  Unfortunately this is not intuitive.[9] 

1.3              Bonuses; a fairer incentive than tax relief

The third objective was to provide an incentive disconnected from taxpaying status, thereby overcoming the conundrum presented by a progressive Income Tax structure which results in a regressive, iniquitous, distribution of tax-based incentives.  The LISA is the first mainstream savings product to offer such bonuses (I have long campaigned to replace all pensions tax relief with bonuses[10]).

1.4              Regulatory Impact Assessment (RIA)

The RIA says that the LISA is to meet “the need for increased flexibility for young people looking to save for the long-term”.[11]  To some extent it achieves this, so one could argue for “yes” in answer to the TSC’s question 10 (“is the Lifetime ISA fit for purpose in its current design?” ).  But given the inclusion of several structural features that serve no consumer purpose, and the omission of others that would be beneficial, one could conclude that the LISA has room for improvement.

2.              The response to the Lifetime ISA

2.1              The pensions and savings industry: opinion divided

The LISA’s purpose has, since launch, been the subject of rumour and suspicion within a defensive pensions industry.  Some say it is a mischievous blurring of the boundaries between pension and discretionary long-term saving, and that it is a precursor to a bonus-driven ISA-centric savings arena (which I would support[12]).

Consequently, some pensions industry participants decided not to offer the LISA, dampening demand.  Today the providers with significant LISA scale include AJ Bell, Cushon, Hargreaves Lansdown, Moneybox, Nutmeg and Newcastle, Nottingham and Skipton Building Societies.

In some respects the LISA marketplace forms part of the battleground between the newer platforms and the pensions industry’s “old guard”.  The former have embraced it, eager to grow their customer bases, whereas the latter (including life companies) have prioritised preserving their pensions franchises, ignoring the LISA (and perhaps hoping that it will be demised).

The retail banks, however, are slowly changing their stance in favour of the LISA (Cushon, for example, was recently acquired by the NatWest Group, with JPMorgan Chase buying Nutmeg).

2.2              The consumer response to the LISA

There have been many surveys of attitudes towards the LISA: it is clear that many people like it.[13]  One survey prompted the sponsor to conclude that “the odd thing is that the pretty much universally warm welcome LISA received from the millennials we spoke to was at odds with the reactions we see from potential providers, distributors, and wealth managers”.[14]  

Since the LISA was introduced in 2017, a total of £9.5 billion has been subscribed, attracting nearly £2.4 billion in bonuses.[15]  Over the last three years, the number of active accounts has jumped by more than 50%, with total subscriptions rising by 40%.  The LISA continues to be the fastest growing mainstream savings product in the market, with £2.07 billion subscribed to 835,000 accounts in 2023-24, up 10% on the year before.[16]  And while LISA subscriptions also rose 10% in 2022-23, those to Stocks and Shares ISAs, for example, fell by 18% that year.[17] 

The OBR is forecasting LISA subscriptions to surge over the next few years, with an additional £14 billion going flowing in by 2030, a huge sum given the LISA’s relatively small number of product providers.[18] 

Meanwhile, some within the more traditional pensions industry continue to criticise the LISA.  They appear to be forgetting that this is the age of the customer.

2.3              The LISA: minimal impact on house prices

House price inflation is a hot political topic, with first-time buyer prices having roughly doubled over the last decade.  In the early years following its launch, the LISA’s contribution to home purchases was obviously minimal (account balances being small).  More recently (2023-24), 56,900 people used a LISA to help buy their first home[19], some 19% of that year’s 293,339 first-time buyers.[20]  But more than 60% of first-home purchases were made jointly (i.e. by two or more parties)[21] so, when compared to the 1.1 million property sales completions[22] in 2024, LISAs were only involved in a small percentage of them.

In 2023 the average first-time buyer deposit was some £53,000 (£109,000 in London), 19% of the average purchase price of £288,000.  The average LISA house purchase withdrawal was under £14,000, a modest contribution to date, but one that could be expected to grow as LISA balances accumulate.

But perhaps more significantly, of the £93.5 billion spent by first-time buyers in 2023[23], only £850 million came from LISA withdrawals[24]; less than 1% of the total capital requirement.

Given all this data, it is clear that the LISA’s contribution to house price inflation is dwarfed by a combination of economic, social, and policy factors.  The main price drivers are:

(i)              the housing supply shortage.  A long-term undersupply of new homes relative to growth both in population and the number of singleton households has contributed to higher prices.  Strict planning regulations and the limited availability of land for development exacerbate the issue;

(ii)              12 years of post-2008 ultra-low interest rates;

(iii)              investment (buy-to-let market and foreign), and speculation;

(iv)              the finite availability of land that is not exposed to the risk of flooding; and

(v)              our aging population.  Older homeowners tend to hold onto properties longer, reducing market supply.

3.              The 6.25% penalty

Unfortunately the LISA was launched with a 25% charge imposed on pre-60 (non-first home) withdrawals, facilitating a 6.25% withdrawal “penalty”.  This arises because £100 saved attracts a £25 bonus, to total £125.  On withdrawal, £125 x 25% = £31.25p, i.e. £6.25p more than the bonus received on the original £100 saved.  This is not intuitive, and is widely misunderstood, not least because it is implicit rather than explicit. 

Last year 99,650 unauthorised withdrawals were made, totalling £301 million (i.e. averaging £3,000 per transaction), and £75 million was paid in charges (including £19 million in penalties).[25]  And while this is tarnishing the LISA brand, for some people the alternative source of funds would be to borrow via a credit or store card….. at a typical APR of 18%. 

The Office of Tax Simplification (OTS) has acknowledged the 6.25% penalty’s scope to confuse, noting that it adds to the challenge on giving advice.[26]  It concluded that the Government should revisit the rules on early withdrawals from the Lifetime ISA, not least to ensure that the LISA rules work effectively for unadvised retail savers.

Meanwhile, some in the pensions industry mischievously refer to the 25% charge as the “withdrawal penalty”, rather than the more accurate 6.25%.

That aside, the 6.25% penalty adds to complexity, serves no consumer purpose and risks counter-productive suspicion of the LISA itself.  And it sabotages the frictionless reversibility inherent in my original LISA proposal, undermining a fundamental objective that I set for the LISA: fluid reversibility, cost-neutral for both parties (saver and the Treasury).[27]  

4.              Liberate the LISA of its age restrictions

4.1              Pre-18 contributions

I gave the Lifetime ISA its name because I intended it to serve from cradle to grave, making manifest the emergence of a lifetime savings agenda (as opposed to “pensions”).  Consequently, the imposition of the 18 to 39 age window for opening a LISA was an unwelcome surprise.  It is limiting and unnecessary, dampens demand, adds to complexity and serves no consumer purpose.

Ideally a LISA should incorporate features that rely on passive acceptance so that, for example, it should be automatically established when a baby’s name is registered, with a provider nominated by the parents…..the personal saving equivalent of workplace auto-enrolment.  In addition, as an early shove (rather than just a nudge) a £500 starter bonus could be added (remember Child Trust Funds[28]?).  

The question of whether 25% bonuses should be paid on pre-18 contributions is for debate.  Critics may argue that bonuses would disproportionately benefit wealthy families, but any form of means testing would add unwarranted complexity.  Perhaps pre-18 contributions could attract a smaller bonus, 10% say (or none at all?).  No access should be permitted until the age of 18 (like the Junior ISA). 

Default features could include a passively managed default fund (with a cap on the underlying fund costs of 0.35% per year), and automatic reinvestment of all income.

If pre-18 contributions were permitted as described, today’s Junior ISA would be redundant; it could then be demised, to simplify the savings landscape for children.

4.2              Post-40 new LISAs, and post-50 contributions

It is currently not possible to open a LISA over the age of 40, a limitation that should be lifted.  Similarly, the LISA’s contributions age ceiling (50) serves no consumer purpose; it should be removed, with the caveat that any contributions made from the age of 50 onwards should be locked in for at least ten years (with allied bonuses).  This would ensure a term commitment to saving in return for the bonuses, eliminating the risk of “round tripping” either side of 60.[29] 

(Note that in respect of pension pots, just prior to the 55th birthday one can contribute and receive tax relief, and then, a few days later, make a drawdown and collect a 25% tax-free lump sum.  From a Treasury perspective, this is not attractive, particularly given that tax relief is intended to engender a term commitment to saving.)

5.              The Lifetime ISA house price cap

It is unclear what policy objective the £450,000 house price cap is intended to deliver, nor what behaviour it is trying to encourage (or discourage).  It serves no consumer purpose, adds to product complexity, and is prejudiced against those living in parts of the UK with higher house prices: it should be scrapped.

6.              The LISA’s contribution limit

6.1              Too low

The LISA’s £4,000 annual limit needs to be raised in the context of:

(i)              the rise in first-time buyer house prices, roughly doubling over the last decade; 

(ii)              the ISA suite’s total £20,000 limit;

(iii)              the Junior ISA’s £9,000 limit, particularly relevant if it were to the demised (as proposed in section 4);

(iv)              the rising proportion of people who consider ISAs to be part of their retirement provision; and

(v)              Treasury affordability in respect of aggregated saving incentives.  Note that as saving within a LISA increasingly substitutes pension saving (amongst the self-employed, for example), expenditure on bonuses is replacing that on pensions’ tax relief.

6.2              The Treasury perspective

The OBR is forecasting LISA bonuses to cost £3.6 billion over the next six years (to 2030), based upon a £4,000 contribution limit.[30]  If the latter were doubled, a crude approach would be to double the expected expenditure on bonuses, equating to an average of £1.2 billion per year.  This is an extremely modest amount when compared to the cost of pensions tax relief; it could be readily afforded by axing additional rate relief (at 45%), for example, which cost £3 billion in 2022-23.[31]

7.              The LISA in the workplace: an opportunity to reinforce automatic enrolment, (ref. TSC question 7).

7.1              Background

(a)              Workplace benefits packages are increasingly out-dated.

The UK’s workforce has undergone a period of dramatic change in composition, over a remarkably short timeframe.  In 2020 some 50% of our workers comprised of millennials, but in 2025 it is nearly 75%.  But workplace benefits packages have yet to reflect this rapid change in the workforce demographic, retirement provision being overly focused on traditional, inflexible, pensions products. 

(b)              Personalisation

It is striking how people refer to “my ISA”, but when talking about workplace saving they de-personalise their membership of “the company scheme”.  A substantial survey evidences that an extraordinary 39% of auto-enrolled scheme members are unaware that they were a member of a workplace pension scheme.[32]  95% had never tried to change their fund, 91% did not know where their funds were invested, 80% did not know how much was in their pension pot, and 34% did not know who their pension provider was.  Very few have identified a beneficiary, should they die.  Personalisation is a prerequisite for engagement.

Ideally, savings derived through work should be as personal as a bank account, unencumbered by the complexity, jargon and paraphernalia of pensions. 

7.2              Employed workers

Employers have long complained that their pension contributions are undervalued by employees, and therefore represent poor value for shareholders.  There are reasons for this, notably people’s dislike of pension products’ complexity and inflexible access, and their distrust of the pensions industry.  Given this, it is in employers’ interests to offer their employees a choice of workplace benefits that includes a Lifetime ISA, attracting the 25% bonus.

(a)              Employee contributions

If the LISA were included within automatic enrolment’s (AE) definition of a “qualifying scheme”, eligible to receive employees’ (post-tax) contributions (plus bonuses), this would:

(i)              help engender a sense of personal ownership and control of savings derived from the workplace; each LISA would, for example, bear the employee’s name; 

(ii)              provide employees with improved access to their own contributions, as per LISA rules;

(iii)              avoid exposure to Income Tax rises during retirement, post-60 LISA withdrawals being tax-free;

(iv)              duck the “net pay” debacle associated with occupational pension schemes[33].  In addition, because the LISA bonus is disconnected from tax-paying status, those with a total annual income (from one or multiple jobs) below the Personal Allowance[34] would still be eligible for it;

(v)              enable those with multiple (typically part-time) incomes each below the £10,000 AE earnings threshold to receive LISA bonuses on all their LISA contributions.  Conversely, separate occupational pension schemes cannot aggregate contributions for tax relief purposes, so those with multiple low-income jobs miss out on tax relief and employer contributions; and

(vi)              use of the word “bonus” rather than “tax relief” helps with a much-needed reframing of the incentives language.  This, plus the LISA’s additional flexibility, would discourage employees from opting out of AE, thereby missing out on employer contributions.  Indeed, including the LISA within the AE framework could encourage employees to make additional contributions in excess of the AE minimum.

Ideally, an AE-eligible LISA within the workplace would be eligible for salary sacrifice purposes and be afforded the same consumer protections as auto-enrolled occupational pension pots, including a low-cost default fund and a charge cap, and

death in service benefits.  In addition, it should benefit from the same Employer Duties and safeguards as specified in the AE legislation.[35]  Furthermore, providers offering a LISA through employers should be required to comply with the FCA’s Consumer Duty, a recently introduced higher standard of consumer protection.  This encompasses the management of long term investments found within pension products.[36]

Consideration should also be given to introducing a trustee-based governance structure, and including the LISA within the remit of The Pensions Regulator (TPR).  A published paper describes in detail how the LISA could be accommodated within the AE framework.[37] 

(b)              Employer contributions to a LISA

Access to employer contributions made under AE should continue to be restricted, i.e. not permitted until the age of 60.  They could either continue to be made into the occupational pensions arena, or perhaps into a separate Workplace ISA where they would be taxed at the employee’s marginal rate, attracting a 25% Treasury bonus.[38]  Withdrawals from the Workplace ISA would then be tax-free….unlike 75% of pension pot withdrawals.

(c)              The employer perspective. 

Inclusion of a LISA within the AE framework would raise an interesting dilemma for employers who already offer an occupational pension scheme.  How should they promote the two different long-term savings vehicles when decumulation of a pension pot incurs an Income Tax liability above the Personal Allowance, whereas LISA withdrawals are tax free?  Employers should consider what is in the best interests of their employees.  However, a LISA and a pension pot are not mutually exclusive, and could be complementary, particularly for high earners looking to save more than £4,000 per year. 

It is noticeable that some employers already make contributions to Group Personal Pensions schemes, and a few of them are now adding the LISA to their GPP arrangements. 

7.3              The self-employed (ref. TSC question 7)

Today, most of the self-employed are not saving for retirement.  Fewer than 16% are contributing to a private pension (48% in 1998) and only some 18% are participating in any form of workplace scheme, a proportion that is also in long-term decline.  The self-employed obviously have no access to an employer-sponsored pension scheme, so they miss out on employer contributions (as well as salary sacrifice schemes[39]).  Perhaps more surprising (and worrying) is the decline in other non-housing related saving by the working age self-employed, down from over 80% in 1998 to 50% today.[40] 

The All-Party Parliamentary Group (APPG) for Financial Resilience recommended in 2022 that automatic enrolment be introduced for the self-employed.  This is welcomed, but the APPG’s focus on pension products is misplaced; many of the self-employed have no empathy for the inflexible pension savings product, its mind-numbing complexity and impenetrable jargon.  In addition, tax relief is an ineffective incentive and there is no employer contribution to motivate the self-employed.

In 2022 I outlined a proposal to the Work and Pensions Select Committee[41] that synthesises an employer contribution for the self-employed by taking advantage of Class 4 NICs being 2% lower than employees’ Class 1 NICs (noting that the self-employed accumulate the same State Pension entitlement).[42]

The self-employed (who like the LISA) could be auto-enrolled into a LISA to pay a 2% (NICs-band-based, bonus-eligible) contribution which would count as a tax-deductible business expense.  This would be accompanied by a default such that non-payment of the 2% into the LISA would result in a 2% increase in the individual’s Class 4 NICs. 

This proposed structure should pass a “reasonableness” test of public opinion, not least because the contents of the LISA would belong to the saver.  There is a world of difference between this proposal (a strong nudge; shove?), which leaves the individual in control, and Philip Hammond’s ill-fated 2017 attempt to increase NICs for the self-employed.[43] 

Given the cost of living crisis, it is a tough time to promote saving, but the combination of a default structure, the opt-out penalty, LISA bonuses, the LISA’s flexible access and its personalisation should make for an attractive proposition.

(iv)              Self-employed LISA delivery: a clear role for NEST

David Bennett’s independent review of NEST for DWP appears to confirm that NEST is well placed to develop and implement a savings product for the self-employed.[44]  His review “recommends that NEST uses the opportunity of its member engagement strategy refresh to identify learnings/insights to inform and maximise effective engagement strategies with self-employed members.  Given NEST’s size, there is a role for NEST to play in innovation in this area.”

In addition, NEST’s Public Service Obligation states that “the trustee must also accept those who are not eligible for auto-enrolment but nonetheless wish to save, such as self-employed individuals and those whose earnings are below the minimum eligibility level.”[45]

Article 19 of the NEST Order already allows NEST to admit workers in certain circumstances where AE obligations do not apply, which includes the self-employed. 

Bennett also refers to the paucity of saving amongst the self-employed, saying that “this is partly because pensions can be seen as inflexible, and other saving products are more appropriate”.  In addition, the self-employed do not have the benefit of an employer’s HR department to guide them through all the jargon and paraphernalia of pension pots.

NEST should be tasked to produce proposals to offer a LISA (which could be rebranded as a Workplace ISA) to the self-employed, which could include a default NEST-managed fund.  This would be a logical extension of NEST’s existing AE role and culturally consistent with NEST’s current membership (concentrated in the low to moderate income segment), as well as being aligned with its Public Service Obligation.  Subsequently, LISA delivery should be open to private sector competition, as per the broader AE framework.

8.              The long term vision for ISAs

As an aside, today’s five different ISAs should be unified.[46]  In this, the digital era, there is no reason why their attributes could not be assimilated into one universal ISA (using digital ring-fencing where necessary, including for LISA bonuses).  Implementation could start with extending the LISA age range as proposed (rendering the Junior ISA redundant) and then merging the Cash ISA and Stocks and Shares ISA into it.  The Innovative Finance ISA should simply be scrapped, not least because it panders to a tiny audience.[47]

This would leave us with an all-purpose Universal ISA vehicle to serve personal and workplace saving from cradle to grave, ideally displayed on a dashboard.  Simplify,  simplify, simplify. 

PART II              Lifetime ISA or a personal pension pot?

9.              Introduction

There are more than 21 million people aged between 18 and 39 in the UK, 30% of the population: they represent a significant part of the savings market.  But, faced with unaffordable housing, student debts, fragmented careers, earnings stagnation, zero hours contracts, minimal defined benefit (DB) provision (bar the public sector), a retreating State Pension age and, perhaps most challenging of all, increasingly having to support an ageing population, many of them are on the financial rack. 

Consequently, few are likely to want multiple retirement savings accounts.  So, if deciding upon a single savings vehicle for the longer term, which one should they choose between a LISA and a personal pension pot?

The criteria are likely to include up-front incentives, contributions limits, tax treatment, and access to savings.

10.              The up-front incentive to save

The LISA’s 25% bonus and tax relief at the basic rate of Income Tax (20%) on pension contributions are economically identical.  Unfortunately, this is not intuitive; the confusion arises because the bonus is 25% of a post-tax amount, whereas tax relief is 20% of a gross (pre-tax) amount.[48] 

Tax relief at 40% and 45% is more attractive than a LISA bonus…..but this is relevant to fewer than 10% of all workers under the age of 40.[49]  However, this figure will slowly rise due to the fiscal drag effect of frozen tax thresholds.

Verdict:              When choosing between a LISA and a pensions product, the size of the up-front incentive to save is a neutral consideration for the vast majority of the under-40 workforce.

11.              Contributions limits

LISA contributions are limited to £4,000 per year (to the age of 50), whereas pensions’ annual allowance is £60,000.[50] 

Verdict:              When choosing between a LISA and a pensions product, the latter’s high contribution limit offers considerable advantage.  But those who can save very large annual sums are probably higher rate taxpayers……in which case they should opt for the pensions route anyway. 

12.              Taxation

12.1              Tax frameworks

Savings products are codified chronologically for tax purposes.  Pensions are “EET”, i.e. Exempt (contributions attract tax relief), Exempt (income and capital gains are untaxed), and Taxed (capital withdrawals are taxed at the saver’s marginal rate, bar the 25% tax-free lump sum).  Conversely, ISA contributions are made from post-tax income, but withdrawals are tax free.  Hence ISAs are considered as “TEE”. 

12.2              But the LISA is, in economic reality, EEE. 

Ostensibly a TEE product, the LISA is economically equivalent to EEE for anyone paying Income Tax at a marginal rate of 20%, i.e. most people, and more than 90% of the under-40’s workforce.  This is because the 25% bonus paid to basic rate taxpayers is economically equivalent to 20% Income Tax; it neutralises the basic rate Income Tax paid before contributing into a LISA. 

Remarkably few people appreciate this fundamental LISA attribute and, worryingly, that includes some financial advisers…..which raises the spectre of mis-selling risk.[51]  For many people, the LISA is the most suitable long-term savings product available. 

12.3              Contributions compared

Table 1 shows how much has to be contributed to different savings vehicles in order to receive a post-tax £100 at retirement, before benefitting from any up-front incentive (bonus or tax relief).   For simplicity, any investment growth is excluded.

Table 1:              Pre-incentive contributions required for a post-tax £100

For example, consider the position of someone who ends up paying the marginal rate of Income Tax at the basic rate, when working and in retirement, i.e. the majority of people.

LISA:              A post-tax £80 contributed receives a £20 bonus, totalling £100.  Post-60 withdrawals are untaxed, leaving £100 net.

Pension:              A post-tax £94.10p contributed receives £23.52p in tax relief (at 20%), so £117.62p goes into the pot.  At retirement 25% of this can be withdrawn tax-free (£29.40p), leaving £88.22p to be taxed at 20%. This leaves £70.60p post-tax, plus the tax-free lump sum of £29.40p = £100

Consequently, a pension pot would require 17.6% more to be paid into it than a LISA, after taking into account the upfront incentives. 

The position of those paying the higher rate of Income Tax when working depends upon their marginal rate in retirement.  Most will benefit from “band shifting” whereby they become basic rate taxpayers in retirement; they would have to contribute £70.60p into a pension pot for a post-tax £100 at retirement, giving them a 13% advantage over the LISA. 

But fewer than 10% of all adults under the age of 40 pay a 40% marginal rate of Income Tax.  And of those who do, and then continue to pay the higher rate in retirement, would have needed to contributed £85.70p, giving the LISA a 7% advantage; this is not intuitive.

12.4              Post-tax sums at retirement compared

An alternative way of comparing the LISA with pension pots is to consider the post-tax amount that would be available at retirement, based upon a post-tax £100 being contributed when working; Table 2.  For simplicity, any investment growth is excluded.

Table 2:              Post-tax sum at retirement for a post-tax £100 contribution

Again, consider the position of someone who ends up paying the marginal rate of Income Tax at the basic rate, when working and in retirement.

LISA:              A post-tax £100 contributed receives a £25 bonus, totalling £125.  Post-60 withdrawals are untaxed, leaving £125 net.

Pension:              A post-tax £100 contributed receives £25 in tax relief, totalling £125.  At retirement, 25% of the total pot is tax-free (i.e. £31.25p), the remaining 75% (£93.75p) being taxed at 20%, leaving £75 net.  £31.25p + £75 = £106.25p net.  

The LISA produces £18.75p more (post-tax) than a pension pot which, again, equates to a 17.6% post-tax advantage.[52]

And again, those who pay higher rate Income Tax while working and in retirement would also be better off with a LISA, purely from a tax perspective, the LISA delivering £8.33p more (i.e. 7% more), post-tax, than a pension savings vehicle. 

The LISA is of course particularly attractive to non-taxpayers because their contributions would still attract the bonus, resulting in a negative tax rate. 

12.5              Verdict: Income Tax and incentives: for most people, advantage LISA

Most people end up paying a  marginal rate of Income Tax of 20% when working and in retirement; for them, the LISA is a more attractive long-term savings product than a pension pot.  The LISA’s 17.6% post-tax advantage is an unambiguous fact, not subjective opinion, which not everyone appreciates. 

It is noticeable that whenever there is a LISA versus pension pot debate within the industry, the focus inevitably is placed on higher rate tax relief as the final arbiter, in favour of pensions.  This illustrates how blinkered the industry is, i.e. focused on the wealthy, not the vast majority of the population.  In addition, it ignores the very real prospect of the higher and additional rates of tax relief disappearing within the next few years, with the introduction of a flat rate of relief (perhaps at 20%).  Furthermore, pension pots’ 25% tax-free lump sum could also be whittled down, perhaps by being capped at £100,000, say.  Indeed, the seminal Mirrlees Review proposed “replacing the tax-free lump sum with an incentive better targeted at the behaviour we want to encourage”.[53] 

Note that pension pots’ exemption from any Inheritance Tax (IHT) assessment has historically been used to promote them over the LISA.  But, following the 2024 Budget, that advantage is set to disappear (from April 2027).

13.              Access to funds

There are almost no circumstances in which pension pot assets can be accessed before the age of 55, and 57 from 2028.[54]  Conversely, access to LISA savings is permitted at any age (from one year after the first subscription).  From 60, there are no penalties, and pre-60 access is penalty-free if funds are for the purchase of the first UK home (to be lived in, not for rental).[55]

For today’s under-40’s, the three years difference between pension pot access at 57 and unconditional LISA access at 60 is unlikely to be a material consideration when deciding, today, between the two savings products.  In any event, pension pot access could well be deferred again, to reflect the last few decades’ improvements in life expectancy, probably before any LISA owner reached 60.

For those who prioritise home ownership over saving for retirement, the LISA’s ready access to buy the first home (and compete in the market with buy to let investors, for example) is a valuable, albeit unquantifiable free option. 

Verdict:              Pension pots cannot compete with the LISA’s early access capabilities; the LISA should be the obvious choice for basic rate taxpayers, and especially those who aspire to own their home.

14.              LISA vs. pension pots: other differences

Pension assets are excluded from means-testing assessments in respect of state benefits, whereas LISA assets are not.  But access to benefits is highly unlikely to be a consideration when choosing a savings vehicle. 

Unlike pension pots, the LISA rules make no provisions for adviser charging (the practice of withdrawing money from a tax wrapper to pay for advice).  Consequently, using LISA funds (pre-60) to pay for advice would incur the penalty charge: changing this rule would most likely encourage more LISA uptake through advice channels.

15.              Effectiveness; the Treasury perspective

Last fiscal year (2023-24), the Treasury provided a net £52.0 billion in incentivising people to contribute to a pensions savings product.[56]  Outcome?  The UK has one of the lowest household savings ratios in the developed world.  Clearly, many people are unmoved by the Treasury’s largesse; Income Tax relief and NIC rebates (invisible to employees) are ineffective uses of scarce Treasury resource.  (It also does not help that the language of tax relief and NICs rebates is incomprehensible to more than half of all adults.)

Table 3 shows that most tax relief goes to those in least need of an incentive to save, with nearly 63% being harvested by higher- and additional-rate taxpayers who represent only 17% of all taxpayers.  A higher rate taxpayer reaps nearly eight times more in pensions tax relief than a basic rate taxpayer.

Table 3:              Distribution of Income Tax relief by marginal tax rate, 2022-23[57]

We need to catalyse a broad-based savings culture, i.e. more people saving more (as opposed to just the wealthy saving more).  The LISA, by detaching the incentive to save from tax-paying status, is helping to achieve this, particularly for the low-paid and the self-employed.

Conclusion

The Lifetime ISA is a very attractive long-term savings product.  For basic rate taxpayers, i.e. most people, it trumps saving in a pension pot in two fundamental respects: tax treatment and access flexibility.

The LISA’s bonus grosses up contributions made from post-tax income, post-60 withdrawals being tax-free; it is as if, economically, it is tax-free.  Conversely, retirees paying Income Tax at the basic rate have an effective rate of 15% on pension pot drawings (30% for additional rate paying retirees).[58]  The LISA therefore produces a 17.6% higher return.

The LISA’s pre-60 access (including accumulated bonuses) to buy the first home is a valuable free option for the saver.  Pension pots cannot compete with this.

But the LISA is unnecessarily complicated.  Simplifying it as proposed herein would make it more consumer-friendly, encouraging a lot more participation from those on low incomes, and also the self-employed.  And including it within the automatic enrolment framework would nudge the industry to engage with it more assertively. 

That said, even in its current sub-optimal form, the LISA should not be abolished (ref. TSC question 5).    For many people, it is the most tax-efficient long-term savings vehicle available.  Scrapping it would not serve the consumer interest.

I would welcome an opportunity to give oral evidence to the Committee.

January 2025