Lifetime ISAs - Strong Product, Weaker Policy

18/03/2016 18:34 | Updated 18 March 2016

At the Budget the Chancellor announced a new savings product, the Lifetime ISA (LISA) to help people save for their homes and their retirement, and with it, extended the maximum tax free limit on ISAs from £15,000 to £20,000. Encouraging more saving is a worthy objective that public policy should be looking to achieve, and this kind of measure will help younger people save for both of these events.

However, like other recent initiatives, such as Help to Buy Mortgage Guarantees, or Starter Homes, they provide an attractive product for consumers now, but may prove much less helpful in the long-run.

The LISA will allow savers under the age of 40 to open a special bank account into which they can deposit up to £4,000 a year (until they're 50), and receive at the end of the tax year up to £1,000 from the government - so if someone signs up at the age of 18, they will be able to pay in for up to 32 years, and thus receive a government bonus of up to £32,000, on top of their eligible savings of up to £128,000, including and additional interest - a generous bonus to incentivise higher levels of saving.

The government bonus will only be available to be withdrawn in a limited number of circumstances before the saver turns 60, namely to be used to buy a house, or in the event of terminal illness. When the saver hits 60, they can withdraw the lot, tax free, and spend it on what they want.

The LISA is simple, generous and therefore likely to be popular. Indeed, it is an extension of the Government's popular Help to Buy ISA - a similar albeit less generous product to give people up to £3,000 bonus for saving to buy a home. When the Help to Buy ISA was introduced to the market, it was hugely popular - Treasury figures showed 250,000 people opened an account in the first two months. Because the LISA is also available to under 40s who want to save not just for their home, but retirement too, take up should be even higher than this.

However, there are two serious problems with the product. Firstly, if this is about saving for buying a home, it may not help that much. Housing is in short supply, and prices are rising rapidly. By 2021, having paid the maximum in to your LISA and thus be eligible for a £4,000 government bonus, average house prices in England and Wales will have risen £50,600 on OBR projections, and thus deposits by a likely £8,000, given that deposits for first buyers are on average 17% of the value of a home. Equally problematic is that the OBR recognise that increasing demand in a housing market failing to supply enough homes will push up house prices, and therefore the LISA bonus may act to counteract its own objectives. This money might be better spent on building new homes that people can afford.

Secondly, the increased ISA limit that has come with the advent of the LISA is regressive - those on lower incomes are unlikely to be able to squirrel away £20,000 per year, and therefore the beneficiaries, as with raising the tax allowance, will be the better off, not those on lower incomes.

There are two further concerns that need to be explored as part of the government's consultation around the product. If the LISA is about encouraging savings towards a pension then it may well achieve this - it also provides a vehicle for the increasingly large group of self-employed or those with several jobs to pay into. However, if it convinces savers that the LISA is alone sufficient, and discourages them from other forms of pension savings (as warned by former pensions minister Steve Webb), then there are risks this could lead to less, not more pension saving among certain groups.

Finally, these changes will cost a significant amount of money - some £850m by 2020-21, and are likely to rise sharply in future as government begins paying out bonuses to account holders. This, plus the Treasury's acknowledged uncertainty on uptake, and the uncertain costs of people transferring their Help to Buy ISAs into the new accounts, suggest the LISA could end up costing much more in future decades.

So, although addressing the UK's lack of a savings culture to be encouraged, and the government's objectives lauded, the design of the scheme could put these very objectives at risk. Consumers may not benefit from the scheme as much as they would hope, with the taxpayer left picking up the bill for higher house prices.

Bill Davies is Senior Research Fellow for IPPR. He tweets at @bill_davies_87