Last year, after scrimping and saving for years, I became a homeowner.
Saving for a home deposit is difficult; I could only manage it with help from my partner, and by living in the North. So naturally, after finally putting down our deposit it was frustrating to hear about a new Help to Buy ISA– offering a 25% Government bonus towards a first-home purchase – being introduced at the end of 2015. I cut my losses, but when George Osborne announced his new £32,000 savings giveaway for the younger generation, he certainly pricked up a few ears – including mine. Maybe I hadn’t completely missed out after all…
Despite the controversies that surrounded the Budget, the Lifetime ISA was certainly one of the highlights – offering a £1 bonus for every £4 saved. The new savings account, scheduled to be introduced in April 2017, is aimed at my generation – available to anyone from the age of 18 up until they’re 40, and designed to help them build a healthy deposit for a first home, and save for their retirement.
But while the Lifetime ISA seems good at a glance, I’ve heard opinions that believe this could be the Government’s sneaky way of eradicating pensions, as it puts even more responsibility on the saver, and also reduces the Government’s tax relief bill, as you’ll see later on. Whether pensions as we know them are axed in the future is obviously yet to be seen, but ahead of April 2017 it’s worth knowing where the best value lies – saving into a pension, or focusing your efforts on a Lifetime ISA?
I’ve done some calculations and developed a case study to determine which option could generate the best return on investment. Jamie plans on only opening a Lifetime ISA, while Sam believes only in pensions. Later, I’ll introduce Annie, to see how a savings plan combining both options compares.
Lifetime ISA
Jamie doesn’t have a pension plan. He was auto-enrolled into his company’s workplace pension plan when it was introduced, but due to his low wage and high outgoings at the time, he opted-out. Even though his wage has increased to the national average (£26,000), he hasn’t re-joined the pension.
The introduction of the Lifetime ISA intrigues Jamie – a potential £1,000 bonus + interest each year sounds great to him. He’ll be 30 by the time the ISA is introduced, meaning he’ll be able to save into it up until his 50th birthday.
What Jamie particularly likes about the Lifetime ISA over a pension is the flexibility. The money doesn’t come out of his wage, he has to manage it himself – but if he’s got extra expenses one month he knows he won’t be losing a chunk to pension contributions. He can top it up to the £4,000 max at any point in the financial year to gain the £1,000 bonus.
Pension
Sam works at the same company as Jamie. Sam’s on the same wage and plans to join the company pension plan at age 30. Their company matches contributions to 3% of their wage – £65 in this case (£780 per year).
Because this added contribution falls short of the Lifetime ISA bonus, Jamie feels as though he’s getting a better deal than Sam.
Monthly Contributions
In order to reach the full Lifetime ISA allowance and achieve the yearly bonus, Jamie sets up a standing order each month.
Sam decides to contribute 15% of his salary each month, getting the additional 3% contribution from his employer (£65 a month).
Their monthly savings and annual total look like this:
| Jamie | Sam | |
| Monthly amount contributed to Lifetime ISA | £333 | £0 |
| Monthly Amount contributed to Pension | £0 | £325 |
| Annual amount contributed to Savings (including Government bonus/employer contributions) | £5,000 | £4,680 |
Jamie and Sam’s individual retirement savings see a difference of £320 each year.
Impact on Wages
Despite Jamie having more in his Lifetime ISA each year than Sam has in his pension fund, it’s interesting to see how the benefits offered on pension contributions can impact your real take-home pay each year.
| Jamie | Sam | |
| Standard take-home wage after tax deductions | £1,737 | £1,737 |
| Take-home wage following Lifetime ISA savings and/or pension contributions | £1,404 | £1,477 |
| Annual take-home wage following Lifetime ISA savings and/or pension contributions | £16,837 | £17,727 |
Even though Jamie has an additional £320 in his Lifetime ISA each year, Sam is actually £890 better off every single year.
This is due to the tax relief offered on pension contributions: the Government tops up your pension contributions by 20% (40% and 45% for high- and higher-rate tax payers). So even though Sam’s fund is increasing by £325 each month (plus employer contributions), he only contributes £260 of this.
Because pension contributions don’t count towards take-home income, Sam ends up paying less in income tax than Jamie does, which is why his yearly net-pay is higher.
Interest Gains
Jamie and Sam are both 30 years old, on the same wage and expecting to retire at 60 – the age you can access the Lifetime ISA funds. While highly unlikely, for the sake of this example let’s also presume their wage and pension/ISA contributions don’t change from age 30.
To understand potential growth, we also need to set some interest rates. We’ll use a 4% interest rate on Lifetime ISAs (the highest interest rate currently offered on the Help-to-Buy ISA) and a 7% pension inflation rate (a figure used by many pension growth calculators).
Unfortunately, under the Lifetime ISA rules, Jamie can’t contribute or gain any Government bonus past his 50th birthday, but he does continue to receive interest until he can access the money at age 60. As you can see in the figures below, Jamie nets approximately £227,400 for his retirement.
| Age | 30 | 35 | 40 | 45 | 50 | 55 | 59 |
| Deposit | £4,000.00 | £4,000.00 | £4,000.00 | £4,000.00 | £0.00 | £0.00 | £0.00 |
| Bonus | £1,000.00 | £1,000.00 | £1,000.00 | £1,000.00 | £0.00 | £0.00 | £0.00 |
| Interest | £160.00 | £1,277.93 | £2,638.06 | £4,292.87 | £6,146.20 | £7,477.79 | £8,747.95 |
| Balance | £5,160.00 | £34,226.15 | £69,589.57 | £112,614.58 | £159,801.08 | £194,422.45 | £227,446.77 |
Sam is able to continue pension contributions until he’s 60; by keeping up the same contributions each month, and with a 7% interest rate, Sam’s pension fund is almost double the value of Jamie’s, at approximately £406,000.
| Age | 30 | 35 | 40 | 45 | 50 | 55 | 59 |
| Deposit | £4,680.00 | £4,680.00 | £4,680.00 | £4,680.00 | £4,680.00 | £4,680.00 | £4,680.00 |
| Interest | £327.60 | £1,484.58 | £3,966.15 | £7,446.67 | £12,328.28 | £19,175.00 | £26,589.03 |
| Balance | £5,007.60 | £22,692.93 | £60,625.42 | £113,827.68 | £188,446.61 | £293,103.52 | £406,432.39 |
Joint Plans
Annie works with Jamie and Sam. She’s starting to save at 30, and earns the same wage as they do.
Annie plans to split her savings between the workplace pension, and the new Lifetime ISA; she feels she’ll get a better deal this way. She wants to contribute 7% of her salary to the pension, and £2,000 each year into the Lifetime ISA.
| Jamie | Sam | Annie | |
| Monthly amount contributed to Lifetime ISA | £333 | £0 | £166 |
| Monthly Amount contributed to Pension | £0 | £325 | £151 |
| Annual amount contributed to Savings (including Government bonus/employer contributions) | £5,000 | £4,680 | £5100 |
| Standard take-home wage after tax deducations | £1,737 | £1,737 | £1,737 |
| Take-home wage following Lifetime ISA savings and/or pension contributions | £1,737 | £1,477 | £1,450 |
| Annual take-home wage following Lifetime ISA savings and/or pension contributions | £16,837 | £17,727 | £17,400 |
Annie’s combined savings look like this after her 30 years of saving:
| Lifetime ISA | |||||||
| Age | 30 | 35 | 40 | 45 | 50 | 55 | 59 |
| Deposit | £2,000.00 | £2,000.00 | £2,000.00 | £2,000.00 | £0.00 | £0.00 | £0.00 |
| Bonus | £500.00 | £500.00 | £500.00 | £500.00 | £0.00 | £0.00 | £0.00 |
| Interest | £80.00 | £638.96 | £1,319.03 | £2,146.43 | £3,073.10 | £3,738.89 | £4,373.98 |
| Balance | £2,580.00 | £17,113.08 | £34,794.79 | £56,307.29 | £79,900.54 | £97,211.22 | £113,723.38 |
| Pension Fund | |||||||
| Age | 30 | 35 | 40 | 45 | 50 | 55 | 59 |
| Deposit | £2,600.00 | £2,600.00 | £2,600.00 | £2,600.00 | £2,600.00 | £2,600.00 | £2,600.00 |
| Interest | £182.00 | £824.77 | £2,203.42 | £4,137.04 | £6,849.05 | £10,652.78 | £14,771.69 |
| Balance | £2,782.00 | £12,607.19 | £33,680.79 | £63,237.60 | £104,692.56 | £162,835.29 | £225,795.77 |
| Lifetime ISA + Pension Fund Total: | £339,519.15 | ||||||
This sits in between Jamie’s Lifetime ISA savings, and Sam’s pension savings. And, despite having over £100,000 more in savings than Jamie, Annie was actually better off each year – netting £17,400 compared to Jamie’s £16,837.
However, despite having over £60,000 more in retirement savings, Sam was even better off each month than Annie was: Sam’s £17,727 compared to Annie’s £17,400.
Lifetime ISAs vs pensions
Looking at these figures, it seems the Lifetime ISA is no match for pensions when it comes to long-term savings. Tax relief and employer contributions available on pensions still play a key role in building a health retirement fund.
What the Lifetime ISA does have in its favour though is flexibility.
Like many young people, saving for retirement is simply not a priority for me – despite knowing how important it is. A Lifetime ISA means I wouldn’t be tied down to saving a set amount each month.
Another advantage it has over a pension is access: having the ability to withdraw some or all of the cash, tax-free, at any point. Even though you’d lose the Government bonus (the whole bonus, not just on the amount withdrawn), those in desperate need of access may favour the Lifetime ISA option over locking their cash away in a pension.
There’s even been whispers of allowing access to a portion of your Lifetime ISA funds with the option of repaying it within a set time frame and not losing the bonus – similar to America’s 401k, and a great rule if true.
Pensions offer a generous way to build a healthy retirement fund but Lifetime ISAs provide the flexibility people of my generation not only expect, but need from their savings accounts. Once I’m auto-enrolled in a pension I’m going to stay there, but the Lifetime ISA is really making me re-think exactly how much I’ll be locking away each month.