LISA & auto enrolment

26 April 2016
Auto enrolment has been a resounding success to date. Six million more people are saving for retirement¹ and opt-out rates remain low². But what happens when you introduce a shiny new investment option aimed at some of these very savers?

This is a question that the Work and Pensions Committee (WPC) have decided to explore. In this article we look at the questions raised and Royal London’s response to them.

Questions

The WPC asked for feedback on the following questions:

  • To what extent is the LISA compatible with auto enrolment ? 
  • What impact could LISA have on opt-out rates? 
  • To what extent will the LISA help the self-employed?
  • Which groups will be better/worse off saving into LISA?
  • What kind of guidance should be made available? 
  • What impact will the option of using LISA savings to purchase a home have on pension savings?

Royal London response

Compatibility

Younger people typically have less resources to draw upon and will now be forced into an either/or decision about the allocation of those resources; saving in a tax advantaged vehicle either for a pension or a deposit on a home. Many will not have the means to make the economically rational decision to save in a workplace pension and a LISA.

Opt out rates

The 2014 DWP study found opt out rates amongst those aged under 30 averaged around 7%[2].

The introduction of LISA requires young savers who would have been auto enrolled into their workplace scheme to make very difficult decisions. For some, the prospect of saving in a product which assists the purchase of a first home, through a generous Government bonus, will outweigh the longer term goal of saving for retirement.

Effect on savings

There is a real risk that, having taken the decision to opt out of the workplace pension and save for a deposit in a LISA when first auto enrolled, young savers will repeat this pattern of behaviour, opting out of each subsequent auto enrolment. Such people will fail to engage with the pension system until such time as it too late to accumulate a meaningful pot.

Which groups would be better/worse off saving into Lisa?

The significant difference between the two savings vehicles competing for the attention of young savers, and the factor that makes them suitable for most savers, is the employer’s contribution available on workplace pensions. 

Based on a person aged 22 earning £26,500 p.a. increasing by 2.5% p.a, and a minimum contribution into workplace pension of 8% of qualifying earnings, by age 60 the pensions saver would have accumulated a fund of £188,170.

If the same person chose instead to save 5% of salary (4% after tax) into a LISA without the employer’s contribution but with the 25% Government bonus up until age 50 the LISA saver’s fund would be £132,673 (a difference of 42%) when they reach 60[3].

The Self-Employed

By definition self-employed individuals do not benefit from any employer’s contribution, nor do they have a charge-capped pension scheme automatically available to them.  In Royal London’s view the self-employed would be real beneficiaries from LISA with the 25% Government bonus for retirement savings held until age 60.

Guidance

In making a decision about where to make retirement savings young savers will not be equipped to take into account the different tax treatments that apply. Nor can the average 20 year-old be expected to take a view on their tax position 40 or more years into the future.  

Royal London believes the proposed new “Pensions Guidance Body” should be given a clear remit to provide help for consumers at the start of their savings journey.

Recommendations

  • In order to ensure adequacy of retirement savings employees should be required to be contributing at least 5% of qualifying earnings to their workplace pension.    
  • FCA should be required to lay out formally guidance on when LISA is a suitable option when there is the option of an employer’s contribution via a workplace pension. Specific risk warnings should also be considered.
  • After the first 12 months HMT should be required to commission a review into sales of LISAs to ascertain if this is genuine source of new savings and not just diverting savings from workplace pensions or, as seems probable, a more tax efficient means of sheltering gifts from parents and other relatives to fund the deposit on a first home.

In conclusion

Anything that encourages people to save more for their financial future is a positive thing, however there is a danger that LISA could result in people delaying saving for retirement until it is too late to for them build up a significant retirement fund.

Due to the employer contribution, most employees would benefit from remaining in their employer’s pension plan. Self-employed individuals may find the LISA more attractive.


[1] DWP Press release: PN16-11  March 2016

[2] Automatic enrolment opt out rates: Findings from qualitative research with employers staging in 2014.

[3] This does not take into account the tax treatment of the two vehicles when they are converted into an income in retirement. The pension will be taxed at the individual’s marginal rate of tax while the LISA income, at least under current rules, is free from tax.  However with the income tax threshold at £11,000 (and rising) fewer pensioners will actual pay tax on their pension income.  

About the author

Fiona Tait

Pension Specialist

Fiona joined the life and pensions industry in 1989. She is a Fellow of the Personal Finance Society, an Associate of the Chartered Insurance Institute and is currently Vice-President of The Insurance Society of Edinburgh. Fiona specialises in the areas of at retirement planning and pensions and divorce.

Last updated: 26 Apr 2016

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