The Lifetime ISA

by George Hatjoullis

The Lifetime ISA or LISA is now with us. If you want a reference then the government website provides some cold hard facts, and the Money Saving expert website provides more discussion. The LISA allows those between 18 and 40 to save up to £4k p.a. and get a 25% annual bonus from the state (maximum £1k p.a.) provided the conditions are met. The conditions are that you do not access the money until you are 60 or unless you are a first time buyer (never ever owned any property) and will use it to purchase a property up to £450k. If you withdraw outside of these conditions you will be penalised (unless you are terminally ill). You get a 25% bonus on up to £4k but you will also be penalised by a 25% deduction if you withdraw outside of the conditions. The arithmetic means you will lose more than £1k if you withdraw and not simply the bonus. To illustrate 25% of 4k is 1k but 25% of 5k is £1.25k. You lose £250. This is an effective 6.25% exit penalty. The LISA only makes sense if you will fulfill the conditions. There are a few issues.

The investment strategy for long-term saving is quite different to short-term, so the LISA could lead to muddled thinking and falling between two stalls. If you are going to invest £4k+£1k p.a. for 32 years (bonus only paid until age 50) and not touch the funds, then investing 100% in equities makes a lot of sense, especially as you are investing continuously over the whole period. If you are expecting to need the funds as a deposit on a property in the next 5 years then holding cash may be the better option. The idea that the LISA offers flexibility is an illusion and a dangerous one. You need to be clear why you have it.

If you are saving for a property then it may make sense*. If you plan to buy in the next 5 years then the state will effectively give you up to £5k of capital to add to your own £25k saved in the LISA. Interest will add a little more but at current interest rates not very much. If you go for equity then there is a risk that, when you come to buy, the value of your LISA will be less than the capital paid in. If you are buying in London then the £450k limit may not be high enough for you to use your LISA. If you are buying jointly the limit is still £450k. It does not double even though you and your partner will have separate LISAs.

The LISA makes more sense as a pension supplement. Employer pension plans are normally preferable because the employer also makes some contribution even if you marginal tax rate is only 20%. You get tax relief at your marginal tax rate up to the allowable limit. The problem with pension plans is that they are taxable when in payment whilst the LISA will payout tax-free. The lifetime allowance and restrictions on contributions limit what high marginal tax payers can pay into pension plans so having a LISA can be an effective booster and one that pays out free of tax. The LISA was not however designed to help high marginal tax payers, at least I hope not.

If you are a 20% marginal tax payer, and do not have a pension plan into which your employer contributes ,then the LISA offers an interesting alternative. The 25% bonus compensates for the fact that your contributions are not tax-deductible. Your withdrawals after age 60 are tax-free. The LISA may make more sense than a personal pension to top up your employment pension. Over 32 years you can contribute £128k and get a £32k bonus. Investment growth will almost certainly leave you with a lump sum at least double this amount. It makes sense but how many 18-40 year old 20% marginal tax payers have £4k in extra savings?

My own conclusion is that the LISA, like many government schemes, is dangerous. It requires quite a lot of financial sophistication to grasp and apply effectively. It may lead to muddled thinking and misapplication. The demographic it is designed to help may struggle to make much use of it and those that perhaps need it least may well be able to exploit it best. For house purchase it is only of marginal value if at all and probably not at all in London.

*If you need to rent your property having used a LISA to buy it you may have a problem. The state must be satisfied that you intended to live in it when you bought but your circumstances have changed. Quite how you prove this is not clear. They may clawback the bonus and treat the use as a withdrawal with the 6.25% effective exit penalty applied. You may however use the rent-a-room scheme.

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