LISA v pensions

The relative lack of change to the pensions tax regime will be welcome news to employers and trustees, particularly whilst last year’s major pensions and tax legislative changes continue to bed in. The chancellor has not given up on revolutionising pensions tax relief; he has merely held off for now. The response to the consultation consisted of a summary of the views received and an assertion that there was no consensus. A substantive government response was conspicuous by its absence.

As anticipated, the lifetime allowance for pensions was reduced to £1m from £1.25m on 6 April 2016, subject to protections for those who have existing savings that may be impacted. The complicated new taper for the annual allowance for high earners also came into force on 6 April 2016.

Pensions salary sacrifice continues and, unlike some forms of salary sacrifice, appears to be safe from change for now.

There will be an increased tax break for employer-funded financial advice. Subject to annual allowance availability (including carry forward), there will be an increased incentive to pay termination payments into pension schemes, as there will be employer NICs on payments over £30,000 from April 2018. Tax rules on bridging pensions will be aligned with the new single-tier state pension. There will also be technical changes to make certain aspects of Budget 2014’s flexibilities for DC pensions work better.

It may be that the lifetime ISA (LISA) is being used to test the waters for tax regime change and that we will see more, and more substantial, examples of the same in the future. To start with, this will be available to under 40s from April 2017. There was no mention of auto-enrolment, which may be telling. Could there be a change of policy to come? The table opposite compares what we know so far about LISAs with pensions.

	LISA	Pension	Comment
Upper age limit	40 to open, 50 for tax relief.	None, but benefits treated as crystallising at 75 for lifetime allowance.	Pensions more flexible, e.g. may be useful in last years of working.
Minimum age to draw	60, except for first house purchase, but crucially can draw at any time if the taxpayer sacrifices bonus and pays 5% charge.	55, but set to increase in line with state pension age to stay 10 years behind. Earlier payment for ill health.	LISA’s main attraction is access, though there is a higher age for penalty-free access. Government may allow taxpayers to repays the LISA early access charge to regain their bonus. Same access on serious ill health as with pension. What about ill health without a terminal diagnosis?
Tax relief on contributions	Effective 20% rate.	Marginal rate.	Higher rate taxpayers benefit more from a pension (up to annual allowance).
Annual allowance (AA) for tax relief	Up to £4k a year. Forms part of £20k annual ISA limit.	Up to £40k AA, but tapers down to £10k for high earners – complicated to work out. £10k DC AA after drawing benefits flexibly.	High earners eligible for both can save in both.
Lifetime allowance (LTA)	No maximum.	Subject to any protection, £1m (indexed from 2018).	LISA attractive for anyone who may reach pensions LTA in future, but the LISA pot will be small by comparison.
Tax during growth phase	None.	None.
Tax when drawn	None.	25% tax free when drawn, remainder taxed at marginal rate.	Pension: tax deferred until retirement and 25% tax free. LISA: no tax relief on contributions but 20% of input amount is tax free. Pension is more attractive.
Inheritance tax	Can be transferred tax-free to spouse’s ISA on death. Otherwise part of estate and subject to inheritance tax if above threshold.	Tax depends on type of benefit, but DC benefits tax free on death before 75 and taxed at marginal rate afterwards. Not subject to inheritance tax if paid under discretion. DC pot can be taken as pension or lump sum, or remain invested to pass down the generations.	Pension potentially more flexible. Much will depend on date of death and the intended benefits and recipients.
Employer contribution	None. Potential for flexible benefits packages to offer portion of salary for ISA/LISA.	Auto-enrolment requires minimum employer and usually employee contribution, both due to increase. Employer contribution may be above minimum. Salary sacrifice permitted, with NIC saving for employer and employee.	Is future of auto-enrolment in doubt? LISA said by government to be particularly good for self-employed. For those eligible for both, choice of where to save above pension minimum may be difficult.
Future proofing against policy change	With tax already paid and bonus received at end of tax year, fairly certain. Expect annual amounts and ages to be changed in future, and maximum lifetime pot size.	History shows government likely to change reliefs and conditions for future saving. Pensions tax relief still under consideration.

Alice Honeywill, Burges Salmon (alice.honeywill@burges-salmon.com)

Issue: 1304
Categories: In brief

Pensions salary sacrifice continues and, unlike some forms of salary sacrifice, appears to be safe from change for now.

	LISA	Pension	Comment
Upper age limit	40 to open, 50 for tax relief.	None, but benefits treated as crystallising at 75 for lifetime allowance.	Pensions more flexible, e.g. may be useful in last years of working.
Minimum age to draw	60, except for first house purchase, but crucially can draw at any time if the taxpayer sacrifices bonus and pays 5% charge.	55, but set to increase in line with state pension age to stay 10 years behind. Earlier payment for ill health.	LISA’s main attraction is access, though there is a higher age for penalty-free access. Government may allow taxpayers to repays the LISA early access charge to regain their bonus. Same access on serious ill health as with pension. What about ill health without a terminal diagnosis?
Tax relief on contributions	Effective 20% rate.	Marginal rate.	Higher rate taxpayers benefit more from a pension (up to annual allowance).
Annual allowance (AA) for tax relief	Up to £4k a year. Forms part of £20k annual ISA limit.	Up to £40k AA, but tapers down to £10k for high earners – complicated to work out. £10k DC AA after drawing benefits flexibly.	High earners eligible for both can save in both.
Lifetime allowance (LTA)	No maximum.	Subject to any protection, £1m (indexed from 2018).	LISA attractive for anyone who may reach pensions LTA in future, but the LISA pot will be small by comparison.
Tax during growth phase	None.	None.
Tax when drawn	None.	25% tax free when drawn, remainder taxed at marginal rate.	Pension: tax deferred until retirement and 25% tax free. LISA: no tax relief on contributions but 20% of input amount is tax free. Pension is more attractive.
Inheritance tax	Can be transferred tax-free to spouse’s ISA on death. Otherwise part of estate and subject to inheritance tax if above threshold.	Tax depends on type of benefit, but DC benefits tax free on death before 75 and taxed at marginal rate afterwards. Not subject to inheritance tax if paid under discretion. DC pot can be taken as pension or lump sum, or remain invested to pass down the generations.	Pension potentially more flexible. Much will depend on date of death and the intended benefits and recipients.
Employer contribution	None. Potential for flexible benefits packages to offer portion of salary for ISA/LISA.	Auto-enrolment requires minimum employer and usually employee contribution, both due to increase. Employer contribution may be above minimum. Salary sacrifice permitted, with NIC saving for employer and employee.	Is future of auto-enrolment in doubt? LISA said by government to be particularly good for self-employed. For those eligible for both, choice of where to save above pension minimum may be difficult.
Future proofing against policy change	With tax already paid and bonus received at end of tax year, fairly certain. Expect annual amounts and ages to be changed in future, and maximum lifetime pot size.	History shows government likely to change reliefs and conditions for future saving. Pensions tax relief still under consideration.