ISA rules revamp aids retirement saving options
The shake up of the ISA regime brings huge opportunities for tax efficient savings. What are the changes and how will they help you?
From 6 April 2017, the total amount which can be saved each year into all ISAs will increase from £15,240 to £20,000. Of this, £4,000 can be contributed to the new Lifetime ISA.
New Lifetime ISA
On 16 January 2017, legislation creating the new Lifetime ISA (LISA) gained Royal assent. This new type of ISA follows on from the Help to Buy ISA, which became available in autumn of 2015. Like the Help to Buy ISA scheme, the new LISA, has the dual purpose of assisting first-time buyers to gain a foothold on the property ladder and helping them to save for retirement. The LISA is certainly the more attractive of the two accounts as you can invest far more and it benefits from increased versatility:
NB: At the time of writing, the LISA rules have not been finalised.
Who can take advantage?
From 6 April 2017, anyone aged between 18 and 39 will be able to open a LISA. Whilst an individual is under 50 they can contribute up to £4,000 per year and receive an additional 25% government bonus. This means for every £4 contributed, the government will add a further £1 (worth up to £1,000 a year). In addition, couples can both benefit from their bonus when they come to buy their first house together.
LISA contributions will count towards an individual’s total annual ISA contribution limit (£20,000 from April 2017), however any bonuses received do not.
The LISA tax-free funds, including the government bonus, can be used to purchase a first home worth up to £450,000 at any time from 12 months after opening the account.
How does the government bonus work?
For the 2017/18 tax year only, the LISA bonus will be added at the end of the tax year regardless of the frequency of the contributions. This means no penalty will apply to withdrawals but likewise a property purchase will not benefit from the bonus in that year. However, from April 2018 onwards the bonus will be paid monthly.
By the age of 50, savers can make contributions of up to £128,000 matched by the government for a maximum bonus of £32,000 with tax-free investment growth on both. For instance, a 25-year-old who made a £4,000 contribution each year that grew at 4% per annum would have almost a five times larger fund by the time they are 60.
Can existing ISAs be used to fund a LISA?
Individuals can transfer any existing ISA savings to fund their Lifetime ISA and this will not impact their annual ISA contribution limit. In addition, any Help to Buy ISA funds that were saved prior to the introduction of the LISA on 6 April 2017 will not count towards their Lifetime ISA annual contribution limit.
Individuals who have a Help to Buy ISA can transfer those funds into a LISA, but this transfer must take place between 6 April 2017 and 5 April 2018 and only one such transfer can be made. At the end of the 2017/18 tax year savers will receive a bonus on the full amount of the transferred Help to Buy ISA and their Lifetime ISA contributions. However, any subsequent transfers made after 5 April 2018 will count towards an individual’s £4,000 LISA allowance. In addition, from April 2018 they will only be able to use the government bonus from one of their accounts to buy their first home.
What are the rules around LISA withdrawals?
Funds can be withdrawn from the LISA at any time and as with all ISAs, withdrawals do not affect an individual’s annual ISA allowance. However, if the withdrawal is not for one of the following purposes, and a penalty charge of 25% will be applied and any bonuses will be reclaimed.
- Deposit for a house, worth up to £450,000
- Retirement income from age 60
- Terminal ill health
This 25% ‘unlisted withdrawal’ charge may seem like the Government simply reclaiming the bonus it paid but the charge is levied on the entire LISA funds withdrawn, including any interest paid and investment growth. Consequently, if an individual incurs a 25% withdrawal charge this could mean that they receive back less than they invested. For instance, a £4,000 contribution plus £1,000 bonus, which is followed by a £5,000 ‘unlisted withdraw’, would be subject to a £1,250 charge leaving the saver with £3,750 (£250 less than their initial contribution amount).
New Flexible ISA
In addition, since 6 April 2016 savers have been able to re-invest withdrawals into ISAs if completed within the same tax year. For example, for the new tax year ending 5 April 2018 an individual who contributed an initial £12,000 then withdrew £2,000, would be able to contribute a further £10,000 into the ISA within the same tax year i.e. the £2,000 withdrawn, plus the remaining £8,000 allowance.
It is more complex if an individual withdraws ISA funds from previous tax years and the current tax year. Withdrawals are first treated as coming from the current tax year’s allowance. When an individual withdraws funds that exceeds the amount that they have contributed within the current tax year, the surplus withdrawn is treated as being from previous years. However, when replacing cash, it is the opposite. Funds contributed back in are treated as replenishing previous years until fully replaced, then the current tax year. Again, the funds must all be replaced within the same year as withdrawn.
Many ISA providers do not currently offer this flexibility. There are also certain kinds of ISAs that cannot be flexible, these are Junior ISAs, Help to Buy ISA and any element of a Stocks & Shares ISA that is not in the cash account.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.