Lifetime ISAs ‘LISAs’ offer a highly tax-efficient way of saving for a first property or for retirement.
The rules
- LISAs can be opened by a UK resident (or overseas crown employee) between the ages of 18 and 39,
- Just like normal ISAs, you can opt for a cash LISA or investment one (aka. stocks & shares),
- You can contribute up to £4,000 per year to a LISA up until the age of 49. Note, this forms part of your overall £20,000 annual ISA allowance rather than being in addition to,
- The key benefit of a LISA vs its ISA brethren is that the government will top-up your contribution with a 25% bonus. So, if you contribute the maximum £4,000 per year, you’ll receive an extra £1,000, automatically credited to the account (normally within c. 6-10 weeks). This is ‘free money’, as long as the ISA is used in the ‘right’ way – see below.
- The funds should subsequently be used either to fund a first house purchase up to £450,000, or in retirement (drawn upon post the age of 60),
- You can access the funds for another purpose – i.e. they’re fully accessible at any point – however, in doing so, you will incur a 25% charge on withdrawal, equivalent to a withdrawal of the government bonus plus a 6.25% penalty.
- Like other ISAs, any subsequent investment income or gains within the LISA are tax-free.
No brainer?
LISAs work best in two scenarios:
i. First-time buyers
LISAs are highly effective for those looking to buy their first property, assuming this is valued at less than £450,000 and is more than a year away (LISAs must be held for at least 12 months).
For parents (or grandparents) looking to help their children onto the housing ladder, one particularly effective strategy is to ‘start early’, regularly saving into a Junior ISA whilst the child is a minor and then gradually switching the funds into a Lifetime ISA from age 18, to capitalise on the government bonus.
This combines the benefits of compounding (earning profits on profits) with the ‘free money’ government bonus.
Consider the following example:
Michael is keen to set up a savings vehicle that will ultimately be put towards a house deposit for his newborn son, Walt. Ideally, he’d like to get to around £70k by his son’s 25th birthday, equivalent to a 15% deposit on a £450k property.
- He sets up a Junior ISA and starts funding this with ‘just’ £100 pm,
- Each year, he increases contributions by 3%,
- The monies are invested in a diversified portfolio and earn an average return of 5% per year net of costs,
- He stops contributing at Walt’s age 18 but instead starts to switch £4,000 a year from the now adult ISA to a Lifetime ISA, to benefit from the 25% government bonus - £1,000 will be automatically credited to the LISA each year,
- By age 25, Walt now has combined ISA and LISA savings of £71k, against total contributions (i.e. the amount paid in by Michael) of £28k.
This is also shown in the chart below:
Disclaimer: These figures are for illustrative purposes only and do not reflect actual investment returns, which can fluctuate and are not guaranteed. You could receive less or more than the illustrative figures above. When investing, your capital is at risk. The value of your investment (and any income from them) can go down as well as up, and you may get back less than you invested, particularly where investing for a short timeframe (we normally recommend a horizon of at least 5 years). Neither simulated nor actual past performance is a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
ii. Retirement top-up
The other areas where LISAs are particularly effective is as a means of topping up retirement savings. That’s because LISAs can also be accessed without penalty from age 60.
This is especially relevant for those who are restricted in making sizeable pension contributions, most notably high earners, impacted by the tapered annual allowance (i.e. the amount you can pay into a pension and still receive tax relief). This is reduced by 50p in the £1 once earnings exceed £260,000, down to a minimum of £10,000 a year for those earning above £360,000.
Whilst contributing £4k a year into a LISA might seem small fry in the context of such earnings, one shouldn’t dismiss the power of compounding, and everyone likes free money at the end of the day.
As an example of the potential value creation, say you were to ‘max out’ LISA contributions, i.e. invest £4,000 a year between ages 18 and 49. Assuming 5% growth per year, by age 60, the LISA would be worth approx. £675k, or around £240k in today’s price terms (assumes 2.5% inflation). That would provide a welcome boost to retirement savings and can be accessed completely tax-free.
Disclaimer: You should be aware that thresholds, percentage rates and tax legislation may change in subsequent Finance Acts and their value depends on the individual circumstances of the investor.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. Since I don’t know your specific situation, none of this information should be construed as tax or financial advice. It is not an offer to purchase or sell any particular asset and it does not contain all the information which an investor may require to make an investment decision. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles.
