There’s a new ISA in town: the Lifetime ISA. Designed to help both first-time buyers and people saving for retirement, it’s certainly an ambitious idea – but does it deliver, and what are the drawbacks? Let’s take a look at this ISA’s finer points.
If you’re a 20-something or 30-something in the UK today, you face a dilemma. Property prices are now so high that it’s all you can do to save up to buy a home. However, people are also telling you to save for retirement – and reminding you that the best time to do this is when you’re young, as you’ll get many more years of compound interest.
The Lifetime ISA (LISA) at least recognises this problem – even if it might not entirely solve it. It’s a tax-free account that lets people build up savings or investments for their first home, for retirement, or both. The big selling-point is an annual 25 per cent bonus from the government on up to £4,000 of contributions per year, to a maximum total bonus of £32,000 by the age of 50. Your savings-plus-bonus can be withdrawn to be used as the deposit on your first home, or from the age of 60 for any other reason. However, the product comes with some important caveats.
What are the pros and cons of a LISA?
The main draw of a LISA for a first-time buyer is of course the generous 25 per cent bonus of up to £1,000 per year. But before you rush to open one, you should bear the following points in mind.
1. Consider your age
You must be aged between 18 and 39 to open a LISA (though you can save into it up to the age of 50).
2. Know your limits
You can pay in a maximum £4,000 per tax year, provided you do not exceed your overall ISA allowance (currently £20,000).
3. Beware the penalty
You can only withdraw your savings-plus-bonus before the age of 60 in order to use as part or all of the deposit on your first home. If you access the money for any other reason, you must pay a 25 per cent penalty.
You should note that this charge doesn’t simply cancel out the 25 per cent bonus, but actually takes away even more of your savings. For example, £1,000 plus a 25 per cent bonus is £1,250. But a 25 per cent charge on £1,250 brings it down to £937 (excluding any interest or growth). So you would actually lose more than 6 per cent of your original investment. For this reason, you need to be confident that you will use the money to buy your first home, if you want it free of penalties before the age of 60.
4. Beware the cap
To qualify for the 25 per cent LISA bonus, the home that you buy must cost under £450,000. For more expensive properties than this, the bonus will not be awarded. This may be a problem if you live in a very expensive area such as London.
5. Remember this if you fall in love with a home-owner!
If you buy a home with a partner, and your partner already owns a home, then only you alone can use a LISA bonus as part of your deposit. Your partner, as an existing homeowner, won't qualify for the bonus, so would face a 25 per cent charge if they were to try to use money in a LISA as part of the deposit. However, you (as the first-time buyer in the couple) will qualify for the LISA bonus as normal.
6. Keep an eye on house prices
The property you buy with the help of your LISA must cost under £450,000. This may be particularly problematic in London, where the average home is already well above this price. It remains to be seen whether the government will raise this threshold in the future if house prices continue to rise. (This limit may also be a problem if you are buying with friends or family.)
Bear in mind too how long it may take you to save up your deposit, as prices could rise significantly during this time.
7. Landlords, look elsewhere
The property must be for you to live in – it cannot be buy-to-let.
8. Maximise your bonuses
You can transfer any funds from a Help-to-Buy ISA built up before 6 April into a LISA for the subsequent tax year without it counting towards the £4,000 annual limit or the £20,000 ISA allowance. This means you can benefit from both the full LISA bonus and the bonus paid to date on the Help-to-Buy ISA.
9. Choose your investment strategy carefully
Both cash and stocks & shares LISAs will be available, but only stocks & shares LISAs were available at launch, and only from a handful of providers. It is however expected that the market will grow, providing more choice.
A stocks & shares LISA can fluctuate in value, so would be more suited to investment over the longer term. People intending to buy within two to three years should treat these LISAs with caution, and may find that a cash LISA is more suitable for them.
10. Keep it for retirement savings
Once you’ve bought your first home (or if you never do), you can use a LISA to continue to save for retirement. You can keep paying in up to the age of 50, and withdraw the savings-plus-bonus at 60.
11. But don’t neglect other savings
Remember that if you have a company pension, this will provide better value for you than a LISA, as it will include employer contributions as well as the 20 per cent tax relief for Basic rate taxpayers (which works out the same as the LISA’s 25 per cent bonus). If you are a higher-rate taxpayer, your pension’s 40 per cent tax relief will beat your LISA hands-down. Furthermore, you can pay up to £40,000 per year into a pension, compared to £4,000 into a LISA.
The LISA does have one key advantage here over a pension, in that you could access your savings in an emergency. However, you would face that 25 per cent penalty to do so before the age of 60 – and in any case your pension is fully accessible from the age of 55.
So if you’re over 18 and under 40, should you take out a LISA? The answer will depend on your plans and individual circumstances, so you need to think carefully – and quite a number of years ahead. Bear in mind that there is no penalty for withdrawal before 5 April 2018, as the first bonus is not paid until then. So the LISA’s ‘early adopters’ will have nearly a year’s cooling-off period.
Broadly, if you plan to buy your own home at any point, then a LISA is certainly worth considering. It’s a good idea to treat the LISA purely as your home-buying fund, and not to neglect other savings, such as your pension and your rainy-day funds. Keeping important finances separate is in any case a useful strategy.
For more help with buying your first home, check out our First-Time Buyer’s Guide.