30 March 2017
Payback time: Lifetime ISAs for millennials
Buy the new savings product for your children
by Frank O’Nomics
Feeling guilty? Come on, you really should. You got a free university education (complete with a subsistence grant rather than a maintenance loan), you’ve benefited from a seemingly exponential rise in house prices and have an index-linked final salary pension scheme that is worth 30-35 times the income it generates. OK, so this does not describe the situation of all baby-boomers, but it covers a great many. How does this compare with the situation for those born since 1990? They have racked up to £40,000 in university debt, the repayments of which impinge on their ability to get a mortgage on a property that costs, on average, a near record 8 times their income. As for their pension prospects, they may be generating some entitlements as a result of auto-enrollment, but they will be a mere fraction of those that old defined benefit schemes produce. I have pointed out here before that, to fill in the gap between half of your final salary (a benchmark used for retirement income) and the money generated by the state pension and an auto-enrollment pot, most people will need to save an additional 10 % of their income in a personal pension. No easy feat. The prospects look grim, but there is a small glimmer of hope on the horizon in the form of something that they can have, which anyone over the age of forty cannot – a Lifetime ISA. A £4,000 investment may not sound like a perfect solution but (bear with me on this) it could be a very good start, and possibly provide a means to ease our consciences.
For most people, finding £9,000 per annum in fees together with the living costs of supporting their children through university is difficult or impossible to do. The option of having their children take on upwards of £40,000 of debt over three years seems the only one. As it is, many will need to add to the money their children borrow so that they can get through their student degrees with a degree of comfort. This sum is likely to be of the order of around £3-4,000 per year, depending on whether the child is able to find part-time employment. It is quite convenient then that £4,000 is the maximum that can be put into a Lifetime ISA. For parents who can’t run to £13,000 per year through the degree period, this could be a very effective way of compensating their children for having acquired a large debt over subsequent years.
There are several benefits in paying your children back in this way. Firstly, the government adds to the pot. For every annual £4,000 put into a Lifetime ISA the government adds £1,000 as long as the money stays in the fund until it is taken out other than to pay for a property or for retirement. So the fund generates an instant 25% return. In this way, even without any additional return, you could effectively pay back your children over 8 years. If you manage to choose a moderately successful fund that generates say a 7% compound return, each £5,000 will double over 10 years. After the first 10 years you will have enough to repay the debt together with an additional sum close to £18,000. Clearly such investment returns may be ambitious, but the beauty of this ISA is that the money will only be taken out to fund either a property or a pension. This helps cover the other two elements of our guilt trip – generating enough money for a deposit for a property and/or a pension pot in addition to anything produced by auto-enrollment. If the millennials earn sufficient to pay off their debts themselves (currently they pay nothing while they earn less than £21,000) then the ISA is there for property or pension purposes. If they do not, then their student debt will be cleared once they are 30 years beyond the initial repayment date, and the ISA pot will still be accruing for retirement income purposes (they can withdraw the money once they are 60). Once you stop paying there is nothing to stop them paying in £4,000 themselves, the government currently commits to a maximum payment of £32,000 ie. £1,000 per year from the age of 18 to 50.
None of this is a panacea for the millennial generation, and there is no way of escaping the accusation that the baby-boomers have had benefits that they can only dream of. Further, if the money is used to fund a property purchase the value of the home has to be under £450,000 – this will be fine for most, but will restrict most Londoners to a one bedroom flat. There is also the risk that people will want to take the money out for reasons other than a property purchase, and if this happens they will have to pay back the government bonus. On the pensions front there will be times when it is more tax effective to save into a pension if the individual’s marginal tax rate is 40% (40% tax relief easily trumps the 25% bonus), although the ISA gives the option of property or pension. Finally, it is clearly not easy for everyone to continue to find £4,000 per child for years after they have left university, when the parent is more likely to be on a retirement income. However, given that those in retirement now have an income that is, on average, greater than those in work, there must be some scope. Further, given that you can open a Lifetime ISA from the age of 18, there is the facility to start the process earlier than graduation. There you have it, a potential solution to our guilt and just possibly a way of ensuring that our children are still speaking to us into our dotage.
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