Should you get a lifetime ISA?

Lifetime ISAs were launched in 2017 to allow people over 18 and under 40 to save for their first home or retirement tax-free. They’re one of the five types of ISA currently available along with cash ISAs, stocks and shares ISAs, junior ISAs and innovative finance ISAs. 

Adults can pay some or all of their annual ISA allowance of £20,000 (in the current tax year) into one of each type every tax year, including up to £4,000 in a lifetime ISA.

What is a lifetime ISA?

A lifetime ISA is a government-backed savings scheme designed to help you save towards your first home, retirement or both. You can put your money into a cash or stocks and shares Lifetime ISA.

You can save up to £4,000 a year into a lifetime ISA and the government will reward you with a 25% bonus of the amount you’ve paid in - adding up to £1,000 extra. Each tax year runs from 6 April to 5 April the following year.

You can only open one between the ages of 18 to 40, although you can pay in and still receive the extra government cash until you’re 50.

You can access the money whenever you like, but only get the bonus if you use the cash to either buy your first home or take it out after you turn 60. If you withdraw the money for any other reason, you will lose 25% of it as the government takes its money back plus a little extra.

How does the bonus work?

The bonus is calculated and paid monthly, so you will earn 25% of the amount you pay in over a year up to £4,000.

For example, before interest is added, if you pay in £4,000 during the first year, your balance would increase to £5,000 with the 25% bonus. You then earn interest or have the potential to get investment growth on the whole amount. If you added another £4,000 the next year, you would get another £1,000 bonus, making your total savings £10,000.

If you only pay in £3,000 over the year you’ll get a bonus of £750, taking your balance up to £3,750 before interest or investment growth.

You can continue to pay in £4,000 a year and earn the bonus until the day before you turn 50. After that, you can keep the money in your account and continue to earn interest or get investment growth on it. 

Who can open a lifetime ISA?

To qualify for a Lifetime ISA you have to:

• Be at least 18 years old

• Be younger than 40 years old

• Be a UK resident (or a member of the armed forces overseas or the spouse/civil partner of one)

Can you have a joint lifetime ISA?

No, you can only open one in your own name, but you and your partner can both take out a lifetime ISA and get the bonus if you qualify.

Can you withdraw money from a lifetime ISA?

There's nothing stopping you taking money out of a lifetime ISA at any point you like - but if you do, you'll lose 25% of what you withdraw.

There are three exceptions to this:

• To use as a deposit on your first home (first-time buyers only) 

• To use in later life (from age 60)

• You’re terminally ill and have less than a year to live

How the lifetime ISA withdrawal penalty works

If you are saving for retirement

From 60, you can choose to withdraw all or part of the money in your lifetime ISA without any penalty charges.

Any withdrawals you make after you turn 60 will be tax-free.

If you are a first-time buyer

• You can only use your savings and bonus towards a new property worth up to £450,000 anywhere in the UK, and if you’re buying with a mortgage

• To qualify for the bonus, you must have your lifetime ISA open for at least 12 months

• You can keep your lifetime ISA open once you use your funds for a deposit and continue savings towards your retirement

If you are buying your first property with someone else, you can both save into your own lifetime ISAs and qualify for two government bonuses.

The money is sent to your solicitor or conveyancer to use when you exchange contracts on a property.

Can you use the bonus if your partner already owns a home?

Yes, if you are a first-time buyer you can use the bonus, even if you are buying with someone who already owns a home.

What if you also have a help-to-buy ISA?

Help-to-buy ISAs were available from 2015 to 2019 to help first-time buyers save for a deposit to buy a home. They have now been replaced by lifetime ISAs but, although you can no longer open one, you can continue to save into one you already have. You can pay in up to £2,400 a year.

You get a bonus of 25% of the amount you have paid in, up to £12,000, from the government via your solicitor or conveyancer when you exchange contracts on a property.  

You can do one of three things:

1. Transfer the money into a lifetime ISA and continue to save. Unless you’re planning to buy a home within the next 12 months, this is likely to be the best option as you can save more into a lifetime ISA each year. 

You’re also paid the bonus every month so you can earn interest or get investment growth on it and you can use it to buy a more expensive home outside London (the limit is £250,000 with a help-to-buy ISA). 

It’s worth keeping the money in your help-to-buy ISA if you’re not sure if you’re going to buy a home that qualifies though as, unlike with a lifetime ISA, you can take your money out of it at any time to use for something else without paying a penalty.

2. Use your help-to-buy ISA for a property deposit and save into a lifetime ISA for your retirement.

3. Use your lifetime ISA with the government bonus to buy a home and withdraw the money from your help-to-buy ISA to go towards your first home or something else (without getting the bonus).

Help-to-buy ISA or lifetime ISA?

You can use both if you are a first-time buyer, but you can only get the government bonus from one of them when using the money to buy your first home.

To get the government bonus on both accounts you need to use them for different purposes.

Has it replaced the need for a pension?

No, but it can help increase the amount of money you can access tax-free when you retire.

If you pay into a workplace pension you’ll get employer contributions as well as tax relief. This means you and your employer both pay towards your pension.

But when you retire, you can only withdraw 25% of your pension savings before the money has income tax applied to it.

With a lifetime ISA, you get less help paying in (the 25% bonus is attractive, but it's less than the income tax, National Insurance and employer contributions available on a workplace pension) - but pay no tax at all when you withdraw the money.

That means that while a lifetime ISA isn’t a replacement for a workplace pension, it can be a useful way to save something extra for later life if you’ve maxed out your employer contributions.

Deciding whether to take out a lifetime ISA

If you’re saving to buy your first home, taking out a lifetime ISA is definitely worthwhile because the government bonus will boost your savings far more than you relied on saving into a regular cash or stocks and shares ISA.

If you’re saving for retirement and you have a workplace pension, you should make sure you’ve saved as much as you can into that first since your employer matches some or all of your contributions. 

Also,  if you’re a higher-rate taxpayer, you’ll benefit more from putting your money into a private pension as you won’t pay income tax on the portion of your salary you add to your pot. If you’re a basic-rate taxpayer there is no difference up to an annual contribution of £4,000 in a private pension because of the lifetime ISA bonus.

Another advantage of a lifetime ISA over a pension is that you can take your money out early if you’re prepared to pay the penalty, while a pension it is locked away until you are at least 55.