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Lifetime ISA loophole could provide double saving boost
Canny savers could use pensions and lifetime ISAs and gain a double tax break, provided the chancellor doesn't close the loophole first.
by Michelle McGagh on Mar 22, 2016 at 11:38
Future retirees could be in line for a double whammy of tax breaks if they transfer their lifetime ISA savings into a pension after age 60, unless the chancellor closes it down beforehand.
Chancellor George Osborne revealed plans for a new lifetime ISA, which will be launched next April, to help younger people save for both a house and their retirement.
The new addition to the ISA stable encourages people aged 18-to-40 to save up to £4,000 a year and receive a government bonus of 25%, up to £1,000 a year, until age 50. This means that for every £4 saved, the government gives you £1.
The money can be accessed tax-free to either buy a property worth up to £450,000, or at age 60 for retirement. If the money is accessed before age 60 and not used to buy a home the government bonus will be removed and a 5% charge will be levied.
Lifetime ISAs are being heralded as an alternative to saving into a pension but of course pensions still remain available and dedicated savers can save into both if they wish, receiving the tax relief on their pension contributions which they would have done previously.
Stuart Adam, senior research economist at the Institute of Fiscal Studies, said the fact that pensions and lifetime ISAs would run alongside each other could provide scope for savers to receive a double tax boost.
He suggested rather than ‘lifetime ISAs…and pensions [being] alternatives to each other’ they could be used together.
‘What you can do is put your money in a lifetime ISA and when you hit 60, up to the limits prescribed (up to the annual pensions allowance) transfer it into a pension and so get the top-up into the lifetime ISA and the 25% tax-free lump sum available through the pension. There is a limit on how much can transfer into a pension but insofar as you can that looks like an extremely favourable option that has been created,' said Adam.
Claire Trott, pension expert at Talbot and Muir, a self-invested personal pension provider, said the loophole in the rules would allow savers to put money into a lifetime ISA up to age 60, and then transfer the tax-free total sum into a pension, receiving tax relief at their highest marginal rate of 20%, 40% or 45%, and then being able to access the fund – including the tax relief – with the first 25% taken being tax-free.
Savers are currently able to save £40,000 each year into a pension, known as the annual allowance. They can also utilise any unused allowance from the previous three years, known as ‘carry-forward’
Trott said this meant money could be moved from a lifetime ISA into a pension quite easily.
However, she said that ‘the allowance is £40,000 gross (including tax relief from the government) so you would actually be able to move less than £40,000’ and this loophole ‘would depend on the system staying the same’.
‘It’s not a massive loophole because the likelihood is people will want to use the money [saved in a lifetime ISA] for income,’ she said.
‘You could also be caught by the money recycling rules, which stop people from making large pension contributions, getting tax relief, and then taking out the 25% tax-free cash right away.’
Mike Morrison, a retirement specialist at AJ Bell, said the rules around how much a person can save into a pension and the reliefs they would receive could be very different in two decades’ time.
‘If you take the money out [of the lifetime ISA] prior to retirement and pay a large pension contribution you will get tax relief but what will the annual allowance be in 20 years’ time?’ he said.
‘It could happen but that’s not the intention.’
The government is already contemplating the future of tax relief on pension contributions and while it shelved plans to move to a flat-rate, many believe the introduction of the lifetime ISA is bringing in a new rate of relief ‘by the back door’, said Morrison
The fact that the rate of relief is 25% for lifetime ISAs ‘does seem to indicate’ the route for a future rate of tax relief.
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