The Financial Conduct Authority (FCA) is consulting on its proposed approach to regulating the promotion and distribution of the lifetime ISA (LISA), saying there is a need for additional rules to address potential behavioural bias amongst consumers because of the complexity of the investment product compared to other ISAs already on the market
The LISA, due to be available from April 2017, is designed to allow people under the age of 40 to save or invest flexibly to either provide a deposit for a first home or save for retirement, with a government ‘top up’ of 25% of contributions, which are limited to £4,000 each tax year up to age of 50. However, investors will lose 25% of any money they withdraw before age 60 for any other purpose
The FCA is proposing to regulate the LISA in the same way as other ISA products, but says additional protections are needed to reflect the dual purpose of a LISA and the restrictions on accessing funds.
In its consultation document, the regulator states: ‘The LISA combines elements of a short-to-medium-term deposit based savings product with a long-term retail investment product. We believe this combination – together with the early withdrawal charge – presents a number of risks to our objectives, particularly our consumer protection objective.’
Firms will be required to give specific risk warnings at the point of sale which include reminding consumers of the importance of ensuring an appropriate mix of assets is held in the LISA. Firms will also have to remind consumers of the early withdrawal charge and any other charges.
The FCA has proposed that providers will have to offer a 30 day cancellation period after selling the LISA, compared to the 14-day period offered for other ISA products.
The consultation document outlines a number of areas where behavioural bias may have an impact on consumers’ decision making. The FCA warns the LISA could be likely to make investors underestimate the benefits of other forms of retirement saving. In particular, investors may not be fully aware of employers’ matching contributions in auto-enrolment and the tax relief associated with pension saving.
It may lead investors to overestimate the potential benefit of accessing funds to buy a house in comparison to investing for retirement or, later, to deplete funds accumulated through the LISA and face inadequate resources during retirement.
Investors may be led to assign an excessive value to the flexibility of the LISA when compared to a pension scheme: in particular, if they underestimate the complexity of the choices in relation to LISA funds, such as the investment profile, whether to buy a house or wait till 60, or withdraw despite the 25% early withdrawal charge, and how to update behaviour when reaching 50.
In addition, the FCA cautions that combined with the ubiquity of the ‘ISA’ brand, investors may be led to miss the early withdrawal charge.
The regulator says that investors may not be able to compare the government bonus on a LISA with tax relief on pensions and higher rate taxpayers (with remaining available capacity for tax relief on pension contributions) and may, therefore, not optimise their retirement savings from a tax perspective if they choose to invest in a LISA rather than a pension. Investors may also not understand the difference in how the proceeds of a LISA and a pension are taxed.
Baroness Ros Altmann, the former pensions minister, described next year’s planned launch of the LISA as ‘a major new mis-selling scandal waiting to happen’, saying there was a high risk that some employees who opt for this approach will be much worse off than they would have been in a workplace pension scheme.
‘I am calling on the providers to wake up to the risks of selling LISAs to people who would be much better off using pensions for their retirement savings. I hope that the Chancellor will recognise these risks and make changes in the Autumn Statement.
‘We should not confuse people about the best way to save for retirement – pensions are unquestionably the best for the vast majority of people. If the Treasury does not understand the risks, then I hope the FCA will clamp down on how these products are sold, to make sure there must be careful suitability checks and risk warnings before people lock money into the LISA, thinking this is an appropriate way to save for retirement,’ Altmann said.
The FCA consultation runs until 25 January 2017, and the LISA rules are due to be published in a policy statement in March 2017.