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Lifetime ISAs: Martin Lewis issues warning about LISA

LISA Money Saving Expert's Martin Lewis during a joint press conference with Facebook at the Facebook headquarters in London. (Photo by Kirsty O'Connor/PA Images via Getty Images)
Money Saving Expert's Martin Lewis Martin is urging chancellor Jeremy Hunt to use his Autumn Statement later this month to overhaul 'unfair' aspects of LISAs. Photo: Kirsty O'Connor/PA via Getty (Kirsty O'Connor - PA Images via Getty Images)

Over half a million Brits have opened a lifetime individual savings account (LISA), introduced in April 2017 to help young people save for retirement and buy their first home.

The average age of LISA holders is 31 years old, the same as the average age of a first-time buyer.

Money Saving Expert's Martin Lewis is urging chancellor Jeremy Hunt to use his Autumn Statement later this month to overhaul “unfair” aspects of LISAs, which are often used by first-time buyers to get on the property ladder.

LISAs are designed to help people aged 18 to 39 buy their first home, or to save for retirement. They can put in up to £4,000 per year.

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The government will add a 25% bonus to people’s savings, up to a maximum of £1,000 per year.

“It would seem that a fair number have opened a LISA for retirement. It’s particularly useful for self-employed people, who are not currently covered by auto-enrolment and so are less likely to have a pension – for this group the LISA can play a critical role in their retirement planning,” said Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown.

How does LISA work?

People between the age of 18 to 40 can contribute up to £4,000 to their LISA every tax year and in return they get a 25% bonus. They can withdraw money tax-free to buy their first home any time after the first year.

Read more: Interest rates: What to do if a remortgage is looming

They can also contribute to their LISA until the age of 50 and withdraw money tax-free from it without paying a penalty from the age of 60. Contributions to the LISA form part of their annual £20,000 ISA allowance, so if they should keep track of how much they have put in other they could face a tax charge.

LISAs are tax efficient — savers won’t pay income tax on any savings that grow in excess of their personal allowance and if they have a stocks and shares LISA they don’t need to worry about paying dividend or capital gains tax.

What’s the catch?

The purpose of a LISA is to help people save for their first home or for retirement. If they take money out for any other reason they will incur a 25% penalty and could actually end up eating into their savings.

In 2021, the government temporarily reduced the LISA penalty to 20% in response to the pandemic. Despite this £34m was paid in penalties last tax year — more than three times the amount paid in the previous tax year. The government has since reinstated the 25% penalty.

MoneySavingExpert.com founder and chair Lewis is arguing that young savers should not be essentially fined, and lose their hard-saved cash, when they buy homes above the scheme’s £450,000 limit.

With house prices having surged over the years, particularly during the “race for space” during the coronavirus pandemic, more people could potentially be at risk than when LISAs launched in 2017.

The same limit applies whether the buyer is an individual or part of a couple. While this is generous enough for many, those buying in more expensive parts of the country, such as London and the South East of England, are much more likely to fall foul of the cap.

Those buying above the current £450,000 maximum, who withdraw their deposit from a LISA, may only get back £937.50 per £1,000 they saved, MoneySavingExpert said.

It said this is because, in practice, LISA savers get the 25% added soon after their funds go into the account.

Read more: Interest rates: What Bank of England's decision means for your finances

So, for example, each £1,000 becomes £1,250. But if savers withdraw the money for reasons other than buying a qualifying property before they are aged 60, they could face a 25% withdrawal penalty, which reduces each £1,250 to £937.50 (ignoring any interest built up).

Lewis said: “So I have formally contacted the chancellor to urge him to make the system fairer.

“Many who have opened Lifetime with government encouragement now have not only a dead duck product, where they won’t get the promised 25% boost, but one with a poisoned beak, because they’re fined to get their money out.

“The simple solution, which could be put into immediate effect, is for a LISA holder purchasing a first-time property for more than the maximum house price, not to be fined.

“So, they lose the government’s 25% bonus, but they get their own money and interest back.”

Who benefits from using a LISA?

Having a LISA and benefiting from the government top up can really boost home deposit saving and even if a person already contributes to a pension, a LISA can be a good alternative vehicle to supplement retirement planning.

Self-employed people may find them particularly beneficial because they don't benefit from auto-enrolment where they automatically contribute to a pension and receive a top up from their employer.

It can play a vital role for employed people too. The impact of the 25% bonus on a LISA is the same as basic rate tax relief on a pension, and all the income is tax free.

Read more: What to do about the hidden horrors lurking in your finances

It means that anyone who is a basic rate taxpayer now, and expects to be so in retirement, who has already taken as much advantage of employer contributions as they can through their workplace pension, could use a LISA for the next chunk of their retirement savings — assuming they’re the right age to qualify.

While one can’t open a LISA after the age of 39 or contribute to it after the age of 50, the contributions they make will continue to benefit from investment growth.

It’s worth opening a LISA with a minimum amount so you can keep your options open in future, said Hargreaves Lansdown, "even if you don’t see how it would work for your circumstances".

How does it differ from a help-to-buy ISA?

Both LISAs and Help to Buy ISAs were designed to help people get on the property ladder. Help to Buy ISAs closed to new applicants in November 2019, but those already have one can continue to save into it until 30 November 2029.

Both products attract a 25% government bonus, but while the maximum contribution to a LISA is £4,000, for a Help to Buy ISA (after the first year) it’s £2,400 — and it has to be paid into monthly.

And while the Help to Buy ISA is only for cash savings, Brits can choose between a cash LISA or a stocks and shares LISA.

Also, a Help to Buy covers first homes worth up to £450,000 in London but £250,000 elsewhere.

Watch: How to live off a student loan

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