What is a Lifetime ISA and how does it work?

A Lifetime ISA (also known as the LISA) is a long term Independent Savings Account (ISA) introduced in 2016. A Lifetime ISA offers all the attractive tax benefits of a standard ISA, but with the additional bonus of a 25% boost provided by the government. The LISA was introduced to help first-time buyers and those looking to save for retirement.

To open a Lifetime ISA you need to be aged between 18 to 40 and a resident of the UK. The maximum annual LISA limit is £4,000 but this is included in your £20,000 ISA limit for 2023/24 tax year. That means you can have a Lifetime ISA alongside a regular stocks and shares ISA, cash ISA or innovative finance ISA. The only caveat is that you have to keep the total contribution below the annual ISA allowance which is £20,000 for the 2023/24 tax year. You can transfer money from any other ISA (including a Help to Buy ISA) into a Lifetime ISA, however this is limited to the Lifetime ISA allowance, which is currently £4,000 for the 2023/24 tax year. So long as you are under 40, you are free to transfer your Lifetime ISA between LISA providers and doing so doesn't affect your annual payment limit. As with other types of ISA, you can only make contributions into one Lifetime ISA in each tax year.

You qualify for bonus contributions on the Lifetime ISA (up to a maximum of £1,000 per year) until the age of 50 at which point you will no longer be able to pay in and the government bonuses stop. Your account will stay open and you will continue to earn interest. The maximum bonus any one person can get with a LISA is £33,000, assuming you have opened an account from the age of 18 and keep it open until the age of 50. However, if you are born on 6th April, this is capped at £32,000.

Lifetime ISA types

Investment Lifetime ISAs (Stocks and Shares Lifetime ISAs)

Lifetime ISA contributions can be invested in a range of investments such as stocks & shares and investment funds. This is known as a stocks and shares Lifetime ISA or stocks and shares LISA. It is important to note that an investment Lifetime ISA carries more risk than just holding your contributions in cash as your investments can go down as well as up and, therefore, should be held for a minimum of 5 years.

If you are looking to use a Lifetime ISA to buy a house in 2 or 3 years, then a cash Lifetime ISA may be the best option as the interest earned is guaranteed. If you are looking to use a Lifetime ISA to save for retirement then an investment Lifetime ISA may suit you better as you could benefit from the likelihood of better returns over a longer period (stocks and shares tend to outperform cash over the long term). However, investments can go up and down in value unlike cash savings.

Cash Lifetime ISAs

Contributions into a Lifetime ISA can be held in cash and will earn interest just like a normal savings account but with the added benefit of being tax-free and qualifying for the government 25% bonus.

Don't forget to make sure you are getting the best interest rate available on your contributions by shopping around, and there is nothing stopping you from moving a Lifetime ISA from one provider to another in order to improve your interest rate.

Can you withdraw the money held in a Lifetime ISA?

Lifetime ISA withdrawals are free if you are:

• Using the proceeds towards buying a first home

• Aged 60

• Terminally ill with less than 12 months to live

• Transferring a Lifetime ISA to another provider

If you want to withdraw your investment for any other reason then you will have to pay a penalty of 25% of the amount withdrawn and this is perhaps the major drawback of a Lifetime ISA. The penalty could mean that you get back less than you paid in.

What can a Lifetime ISA be used for?

Property purchase

• A Lifetime ISA can be used by a first-time buyer towards purchasing a UK residential property once the account has been held for 12 months. So if you want to buy a house in less than 12 months time a LISA is not for you, but a Help to Buy ISA may be the preferred option if you opened one prior to the November 2019 deadline.

• Any property purchased must be valued at £450,000 or less and must be the first property owned, wholly or in part, by the applicant. While the property value limit seems high it may restrict those buying a property in London due to the inflated property market there.

• If you are looking to buy in London there are some new government schemes in place to help you buy your new home; explained in more detail by Money Helper (formally the money advice service).

• The money saved in a Lifetime ISA will be paid directly to the conveyancer/solicitor not directly to the investor

• The property purchase must complete within 90 days from the withdrawal. If the property doesn't complete it can be transferred back into the Lifetime ISA with no loss of bonus

• The Lifetime ISA is designed to help first-time buyers get on the property ladder so all purchases must be made with a mortgage or the 25% bonus will be sacrificed

Retirement

• A Lifetime ISA can be used to fund retirement once the applicant reaches the age of 60

• At age 60 all or part of the investment can be withdrawn with any remaining investment left to continue growing

• All proceeds are tax-free, unlike a pension, but could affect eligibility for some means-tested benefits

• Contributing to a Lifetime ISA does not have any impact on your workplace pension (if you have one). You can contribute to both

Are Lifetime ISAs worth it?

Lifetime ISA Pros

• The government bonus of 25% is generous and will boost any savings made

• All proceeds from a Lifetime ISA are tax-free

• Easy to open with low minimum contributions

• Savings in a Lifetime ISA can be held in cash or invested in a range of products through an investment platform

• If investing to finance retirement then all withdrawals will be tax-free, whereas pension income is taxed at the recipient's marginal rate. I do however have reservations about the suitability of a LISA for retirement saving.

Lifetime ISA Cons

• Proceeds from a Lifetime ISA have to be used for a house purchase or left invested until age 60, otherwise a 25% exit charge will apply

• There may be better ways to save for retirement such as a pension provided by an employer where contributions may be matched by the employer

• For higher rate taxpayers it may be more beneficial to invest in a pension as they will receive 40% tax relief on their contributions

• Benefits from a pension can be taken from age 55 rather than age 60 for a Lifetime ISA

• Lifetime ISAs may be altered or withdrawn at any time.