What is a Lifetime ISA and should you open one?

The Lifetime ISA was introduced in April 2017 as a new type of tax-free savings and investment account to help you buy your first home and save for retirement.

What is a Lifetime ISA?

The Lifetime ISA (LISA) allows you to put up to £4,000 per year into a savings account between the ages of 18 and 50. At the end of each year, the government will give you a bonus of 25% – so, an additional £1,000 if you save the maximum amount. That’s a lot of free money if you put away £4,000 every year.

Compare Lifetime ISAs with our partner Money.co.uk

If you withdraw from a Lifetime ISA, also known as a retirement ISA, to help get a mortgage on your first home, you can then continue to use it for its second purpose: saving for retirement. Because young people are motivated to save for their first home but less so for retirement, by combining the two, the government hopes they’re more likely to continue saving for retirement.

Like other ISA products, you can have a cash Lifetime ISA that earns you guaranteed interest – or you can have a stocks and shares LISA, where your savings can make gains or losses.

The LISA forms part of your overall ISA allowance, so if you paid in the maximum LISA amount of £4,000, you’d still be able to contribute a further £16,000 into other types of ISA.

Why should you get a Lifetime ISA?

The Lifetime ISA is designed to help you save for your first home, save for retirement or both.

It can be used to buy a property together with your partner if both of you meet the eligibility criteria, so potentially you can double your 25% government bonus. If one of you has already owned a property, the other can still use a Lifetime ISA.

The Lifetime ISA can also be used to save for retirement, but you can only access your LISA funds penalty-free when you’re 60. You can open a Lifetime ISA between the ages of 18 and 39 (but you can continue saving into a LISA until you’re 50).

At that point you can access your funds and use them for whatever you like. You don’t have to withdraw the whole amount, you can make partial withdrawals and all withdrawals are tax-free. Any remaining funds continue earning interest or investment gains or losses.

You shouldn’t rely solely on a LISA for retirement saving as it’s different to saving for a pension through auto-enrolment or another workplace pension. When you save through a workplace pension, you will get extra “free” money through employer contributions and government tax relief, which you don’t get with a Lifetime ISA.

A Lifetime ISA works in the exact opposite way to normal pension savings in that you pay income tax before you put money into a LISA – but LISA withdrawals are tax-free, while pension payments when you retire are taxable income.

If you are self-employed – and thus have no employer to pay into your pension – a Lifetime ISA is an attractive way to save for your retirement.

How to use a Lifetime ISA

If you use your Lifetime ISA to buy a first property, or withdraw the funds on or after you reach 60, there aren’t any penalties. If you want to spend the money on anything apart from a first property and you’re under 60, you’ll face a hefty 25% penalty on withdrawal.

The only other scenario where you won’t be penalised for withdrawing is if you are terminally ill with less than 12 months to live. If you die your LISA will end on the date of your death and there’ll be no charge for withdrawal.

When buying a property you must be a first-time buyer who has never owned a home in the UK or elsewhere. The property must cost less than £450,000 and be a UK residential property.

You must buy it with a repayment mortgage and live in the property, so it can’t be rented out or used as a holiday home.

When buying the property the funds must be paid directly to a conveyancer or solicitor by your Lifetime ISA provider. Your LISA must have been open for at least 12 months before you can withdraw funds from it to buy your first home.

You face a withdrawal charge if you decide to transfer your Lifetime ISA to a different type of ISA, but not if you transfer to another Lifetime ISA provider.

Withdrawals are potentially expensive because not only do you lose the bonus but you get back less than you put in. For example, if you invest £8,000 over 2 years and get the government bonus of £2,000, you have £10,000. If you withdraw early you lose 25%, which is £2,500 – so you only get back £7,500 and lose £500 or 6.5% of your investment.

All gains are free of income and capital gains tax. You can open multiple Lifetime ISAs but you can only open and pay into one each tax year. You can transfer between different Lifetime ISAs without affecting annual ISA limits.

Lifetime ISA vs. Help to Buy ISA

The Help to Buy ISA is now closed to new customers. If you opened a Help to Buy ISA before November 2019, you can continue to pay into it until 30th November 2029. But would a Lifetime ISA be a better option for you? 

If you’re saving for a first home, the Lifetime ISA allows you to potentially receive a bigger bonus than the Help to Buy ISA. With a LISA you can get a bonus of £1,000 per year for 32 years if you pay in the maximum contribution, but obviously you’d like to get your first home before then. 

The LISA can be combined with the Help to Buy ISA to buy your first home, but there are strict rules governing this. If you already have a Help to Buy ISA, you can transfer these savings into your Lifetime ISA or carry on saving in both, but you can only use the bonus from one of the schemes to buy your first home.

You can transfer the balance from a Help to Buy ISA into your LISA if the amount isn’t over £4,000.

There are other differences too. You can make lump sum payments into a LISA, but you have to make regular monthly payments with the Help to Buy ISA. The Help to Buy ISA contribution limit is £2,400 annually, so the maximum bonus is £600 per year and £3,000 overall because the Help to Buy ISA runs for a maximum of 5 years, compared to £32,000 for the Lifetime ISA which can run for up to 32 years.

The Help to Buy ISA has a property price limit of £450,000 in London and £250,000 elsewhere in the UK, but for the LISA the limit is £450,000 anywhere in the country.

Overall, if you plan to save for longer than 5 years or if you can afford to save more than the Help to Buy ISA limit of £2,400 a year, then the Lifetime ISA pays a higher bonus.

Where can you get a Lifetime ISA?

Some ISA providers have opted not to offer LISAs because they say it’s too complicated.

For cash LISAs, Moneybox and Nottingham Building Society offer some of the best rates around paying 1.1% and 1.05% respectively.

There are more options available for investment LISAs. Hargreaves Lansdowne and AJ Bell are investment platforms that allow you to invest in a wide range of investment choices. They charge fees and you could lose money, though the gains are potentially higher as well. 

6 November 2020