Everything you need to know about Lifetime ISAs

The UK government designed the Lifetime ISA account to encourage people to save for their first home. It is, without doubt, the most efficient way to save for this purpose. It can also be used for your retirement after the age of 60.

Reasons to use

• Deposit up to £4,000 a year and get a 25% bonus free
• Can be used to purchase your first home or for retirement
• Can earn interest or stock market gains

Reasons to avoid

• Value of your home must be under £450,000
• 25% fine for early access of funds
• Must be used with a mortgage and never with a private loan

The Lifetime ISA is designed to help you get on the property ladder. It helps by providing a government bonus of 25% on all deposits made into the account, up to the value of £4,000 per year. That means you can save up to a maximum of £5,000 a year towards your first deposit. The money you save can also be used for your retirement once you reach the age of 60.

Of course, the government bonus of up to £1,000 is significant, but you’ll also benefit from interest (if you open a Cash Lifetime ISA) or investment gains (should you open a Stocks and Shares Lifetime ISA) which can help grow your savings. And because they are housed within an ISA, all gains are tax-free.

There are a few rules surrounding this account which it is important to familiarise yourself with if you are to use it to its full potential.

To be eligible for a Lifetime ISA, you must meet the following criteria:

• You must be between the ages of 18 and 39.
• From the start of the 2024/25 tax year, you will be at liberty to open more than one Lifetime ISA in the same tax year.
• You must not have exceeded the ISA annual limit of £20,000. The annual limit can be split between different types of ISA.
• You must be a UK resident for tax purposes, a civil servant working outside the UK, or their civil partner.

You can continue to save up to £4,000 a year into your Lifetime ISA until you reach the age of 50 and your 25% bonus will continue to be paid on contributions you make each year until this age.

You can only use the money in your Lifetime ISA after 12 months of your first deposit into the account. The Lifetime ISA must be used to purchase your first home with a mortgage (you cannot use it in conjunction with a ‘gift’ or ‘loan’ from friends or family) or for retirement when you reach the age of 60.

If you withdraw the money held in your Lifetime ISA for any reason other than to purchase your first home, or for retirement after the age of 60, you will be fined 25% of the total amount for the ‘unauthorised withdrawal’.

The money you save into a Lifetime ISA will count towards your annual ISA allowance of £20,000 for the 2024/25 financial year.

The major flaw is the property purchased using these savings must cost £450,000 or less. This figure has not increased since April 2017, despite UK house prices experiencing a 33% hike in price since that date.

So, should you be looking to buy a property somewhere like central London, you may struggle to remain within the cap, and any purchase in excess of £450,000 will result in a 25% fine.

The other flaw to be aware of is the fine imposed should you need to access your money for any reason other than for the purchase of your first home, or for your retirement.

Whilst the fine is designed to recover the original government bonus, it does in fact go beyond this and results in account holders sacrificing a portion of their own savings. It also means the account holder will lose a portion of their gains from interest or investments.

To illustrate how the fine penalises savers beyond the government bonus, we will assume zero gains from interest or investments.

• You deposit £1,000
• You then receive a £250 bonus
• Total in your account is £1,250
• You withdraw and incur a 25% fine amounting to £312.50
• You are left with £937.50
• You have lost £62.50 of your original deposit

Remember, while the potential reward is greater when it comes to investing, so is the potential risk. That being said, there are a number of assets that you can invest in via a stocks and shares LISA including:

• Stocks and shares
• Unit trusts
• Investment trusts
• Exchange-traded funds (ETFs)
• Government or corporate bonds
• Open-ended investment companies (OEICs)

However, it is important to know that not all assets are available on all platforms, and you should therefore check the platform website before opening an account.

Risk-adverse savers, or those seeking to use the money in their LISA within 5 years, may be best served with a Cash LISA.

There are platforms that offer ready-made portfolios that provide a quick and easy way to invest your Lifetime ISA. However, historical performance has been variable and while this should not be considered a guarantee of future results, it is certainly worth considering.

The following analysis has been conducted in-house and is exclusive to Investing Insiders.

For more information to help you choose a provider for your Lifetime ISA, please refer to the article Best Lifetime ISA.

Both these products are designed to help you save for retirement, therefore you may be wondering which is better. The answer depends on your circumstances. However, there are some key points to consider.

Your tax bracket

A pension works by offering tax relief on your contributions. That means, if you are a basic rate taxpayer, your contributions will get 20% relief on your deposits which is automatically added to your pension account. Higher-rate taxpayers will get additional tax relief, up to the value of 40%, so the bracket you fall into will dictate how much tax relief you can earn. The Lifetime ISA has a fixed bonus of 25% and is, therefore, better for some basic-rate taxpayers.

Your intended retirement age

Currently, a pension can be accessed at the age of 55, although this is due to increase to 57 in 2028. Conversely, a Lifetime ISA cannot be accessed for retirement purposes until you reach the age of 60.

Withdrawing your retirement funds

There are different tax rules when it comes to withdrawing funds from these two products. Pension accounts are subject to tax when it comes time to withdraw your pension savings. The amount you pay in tax depends on how much income your pension provides you. The tax bands are exactly the same as normal income tax bands, with the basic rate lying at 20%.

Conversely, withdrawals from a Lifetime ISA are exempt from tax, although you should bear in mind that you would not have had tax relief on the contributions you made to the account.

The amount you wish to contribute

Remember that the maximum amount you can contribute to a LISA in any one financial year is £4,000. At the same time, pension savers are at liberty to contribute up to £60,000 to their pension pot in the 2024/25 tax year, so there’s a discrepancy there.

Your employment status

If you are enrolled in a workplace pension scheme, your employer must also contribute towards your pension. With a Lifetime ISA, all contributions are your own.

Remember that you are at liberty to open both a pension account and a Lifetime ISA.

Have a question about Lifetime ISAs that we haven’t covered? Ask the Insiders!