Lifetime ISA - inflation or confusion

dqnet

A quick question, if one was to open a Lifetime ISA with a provider that provides 0% interest and doesn't care to invest the money so ultimately just putting the £4000 into some sort of dormant account in order to claim the bonus, are they effectively beating inflation anyway because of the 20% bonus?

I'm not really concerned with the 'why would you not invest it to make more'. I was more interested in knowing if the government 20% bonus on every £4000 one invests every year is beating inflation year on year (being 20%) until one turns 50 and then is it a question of a small decline year on year until they are 60 in order to withdraw it until they are back in line meaning they have exactly the same value then as they have now so no real value loss? Basically no better off and no worse off, with the same spending power)?

Is that also the case with the 20% tax relief the government gives on SIPP pensions too (again assuming no investment and just making use of the 20% on the way in and making sure you take out under your tax margin [so nothing to tax] on drawdown)

cheers

bowlhead99

Assuming 3% inflation, you would need your £1000 to have turned into at least £1267 over eight years to still be able to buy the same basket of goods and services you could buy for £1000 today.

E.g. £1000 now needs to be £1030 next year or £1061 the next year or £1093 the year after etc etc etc to preserve its spending power.

So basically the £250 you get in bonus on a £1000 Lisa contribution or in tax relief on a £1000 pension contribution, is fully eaten up by inflation within eight years of getting it. All of the money you put into a LISA by the age of 50 will be in the LISA for more than 8 years before you can take it out at age 60. So, if you somewhat stupidly save or invest it in assets returning 0% per year, the bonus will be entirely eroded by inflation and some of your capital contribution will too.

Still, if you didn't have the bonus in the first place, and stupidly put all your money into savings accounts or investment delivering 0% for a decade or more, you would have suffered an even larger erosion of your capital.

Is that also the case with the 20% tax relief the government gives on SIPP pensions too (again assuming no investment and just making use of the 20% on the way in and making sure you take out under your tax margin [so nothing to tax] on drawdown)

The philosophy is the same for £1000 turning into £1250 in a pension as it is in a LISA. 25% is not enough to cover more than a few years inflation. Things now are twice as expensive as they were in the '90s, so getting 25% towards that 'loss' doesn't cover it. But better to have the bonus money than not have it, if you can handle waiting for the Investments to mature for a good while before you're allowed to cash out.

The advantage with pension over LISA is that you can get bigger tax relief amounts than that if you're a higher rate taxpayer, and the amounts are outside your personal estate for inheritance tax and debt collectors and means testing. While the advantages of Lisa over pension include not having to manage the withdrawals within a tax allowance (which might be difficult if you have other income or want to access a lot of money at once) and the fact you can access the money before retirement in an emergency if you don't mind paying a penalty.

But both LISA and pension get hit the same by inflation because goods and services will increase in price whether you choose to use or ignore the various tax wrappers and government gifts that are available.

I was more interested in knowing if the government 20% bonus on every £4000 one invests every year is beating inflation year on year

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It will beat inflation in the one year you first get it because inflation is less than 25%. After that if you don't grow the money through interest rate or investment growth, it will lose to inflation in every subsequent year.

So in year 1 you get the bonus on the first £4000 which turns it into £5000 and easily covers the inflation for that one year on that £4000. In year 2 if you add another £4000 you will get the bonus on that *second* £4000 but you won't get another bonus on the first £5000 you had from year one. That £5000 left over from year one will decline in value due to inflation and might only be worth £4850 in real terms. And it won't get any more bonuses and it will keep declining in real terms and after a decade it won't be 'worth' as much as it started at, even though it had that nice initial bonus.

dqnet

This explains it perfectly - thank you so much bowlhead.

I was looking for the ultra easy way out by merely thinking "who cares about investment 20% will cover it"