Over the years, I’ve had a few questions about Lifetime ISAs (LISAs). As they are a relatively new product, only six years old or so, there doesn’t seem to be a huge amount of understanding out there on the features and benefits.
What follows is a more comprehensive answer than I have ever been able to give on the spot to my mates. Please remember that none of the following constitutes advice mind, and as ever if you have any questions regarding your specific position you should always look to speak with a regulated financial adviser.
At the outset, in the interests of full disclosure, I think that the Lifetime ISA is a cracking little product. It can offer a decent complement to pensions and ISAs for the right person, but it is often overlooked due to a lack of willingness on the part of providers to offer it.
How does a LISA work?
LISAs can be opened by UK tax residents between the age of 18 and 39. Once opened and until you reach the age of 50, one can contribute up to £4,000 each tax year to a LISA and the government will top this figure up by 25%. So in a given year you can save up to a maximum of £5,000 including the government bonus.
As the LISA is a kind of ISA, any investment returns or interest that you earn on your savings is tax free. Any contributions that you make into the LISA (but not the government bonus) come out of your annual £20,000 total ISA allowance.
The funds within a LISA (including the government bonus) can be withdrawn tax and penalty free in three different scenarios:
1. You are buying your first home, up to the value of £450,000. The LISA needs to have been opened and funded for at least a year before using it for a property purchase;
2. You are over the age of 60; or
3. You are terminally ill, and have less than twelve months to live.
This is really important so listen up. The penalty for withdrawing from a LISA for any other reason than prescribed above is punitive – it is 25% of the total amount withdrawn, you don’t just lose the 25% government bonus(es) that have been credited to the account.
As an example, if you had saved £4,000 into a Lifetime ISA and received the full £1,000 government bonus – then had decided to withdraw all of your funds for an unapproved reason, the penalty would be 25% of £5,000 or £1,250. You’d be left with £3,750. Not ideal.
Cash LISA or Stocks and Shares LISA?
Just like a normal ISA, you can choose to open a Cash LISA or a Stocks and Shares LISA. You will receive tax free interest on a Cash LISA, and any growth or income that you receive from investments within a Stocks and Shares LISA will also be generated tax free.
Interest rates on Cash Lifetime ISAs aren’t all that hot at the moment, with MoneyBox offering the highest rate in the market at 4.25%, but this drops to 3.5% after twelve months.
If you are looking for more bang for your buck, then a Stocks and Shares LISA offers the potential for higher returns – but as ever with investing you have to remember that there is also the potential for loss.
As a rule of thumb, I would normally only ever recommend to a client that they should consider investing when they are able to leave the money alone for a minimum of three years. Therefore if you are going to need your LISA savings in the next three years to purchase a property, then I would suggest sticking with a Cash LISA.
Remember – when investing the key question to ask yourself is “when will I need this money?”. The answer to this question is the main factor in determining the correct investment strategy for you.
One of the drawbacks of going down the Stocks and Shares LISA route is that you have to find an appropriate investment product to invest your money into.
However, Nutmeg and MoneyBox both offer risk managed investment funds and guidance on which is appropriate for you given your risk tolerance. If you are working with a financial adviser they can also help here too of course.
If you are more confident in selecting investments yourself then there are a number of “DIY” platforms which offer Lifetime ISAs – Hargreaves Lansdown and AJ Bell are two well established names.
LISAs versus ISAs
So Lifetime ISAs have a lot to offer for the right person. But every pound that is contributed to a Lifetime ISA is being taken away from another potential savings vehicle. There is a lot of choice.
I am painfully aware that weighing up which tax wrapper is the best option for your hard earned cash isn’t necessarily the most exciting of topics. But if you’ve stuck with me this long, I’ll assume you agree on the importance of getting the basics right.
The main advantage that an ISA has over a Lifetime ISA is flexibility. You can get your money out of an ISA, tax free, anytime and without penalty. LISAs, as we have seen, are subject to eye watering exit penalties if you take withdrawals for non-approved reasons.
If you are at all unsure of whether you will actually end up using the money for a first time property purchase, or whether you are able to lock the money up until you are sixty – then given the choice between a LISA and a regular ISA, I’d say you are better to play it safe and go with the ISA. Even if you are missing out on that lovely 25% bonus.
LISAs versus Pensions
For anyone who is opening a LISA today, they won’t be able to access their pension savings until the age of 57 as a minimum. So for the vast majority of people then, if you are going to use your LISA to fund a property purchase then we are comparing apples with sheep. There is no contest, the LISA is your only option.
Let’s say however that you are planning to use the LISA to save for retirement. Which wins, pensions or LISAs?
This gets a wee bit more complicated, but I have some thoughts.
- For higher rate and additional rate taxpayers pensions handily trump LISAS, due to the far larger income tax relief available on pension contributions relative to the 25% LISA bonus.
- For basic rate taxpayers, it is a closer run thing. However, employers are compelled by law to contribute at least 3% of your annual salary into your pension each year (free money). Many are more generous – offering “matching” schemes such that if you contribute, say 5% of your salary into your pension each year your employer will match it (more free money).
- Provided you earn enough, you can put up to £60,000 each tax year into a pension while Lifetime ISA contributions are limited to £4,000.
- There are no age restrictions on when you open a pension, and “auto enrolment” rules mean that pensions are automatically opened for almost every employee in the country when they get a new job.
- Lifetime ISA savings can only be accessed, without penalty, at the age of 60 for retirement purposes. Most standard pensions allow access to savings from 55 currently, although this is rising to 57 in 2028 and I expect this “normal retirement age” will continue to climb into the future.
- Withdrawals can be taken tax and penalty free from LISAs, but only in certain circumstances. When it comes to drawing from your pension only 25% of the value of your pension is available tax free. The rest is taxed at your marginal income tax rate at the time.
On balance and in my opinion, for retirement savings priority should generally be given to using up your available pension contribution allowances before turning to LISAs.
As I say, none of this constitutes tax advice. If in doubt consult an accountant, or regulated financial adviser.
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