What is a Lifetime ISA?

Woman in a green sweater looking at her pink piggy bank, holding it in her hand.

Savings

MoneyPlus Features Team

14th April 2016 at 2:53pm

Much has already been written about the new arrival in the savings family, the Lifetime ISA, which was announced in the March 2016 Budget. Here are the details.

What exactly is a LISA?

The Lifetime ISA will be available from April 2017 for those aged 18-40, giving them a new option when it comes to saving for their first home or topping-up their pension savings.

With a LISA, they’ll be able to save up to £4,000 a year and benefit from a Government bonus of £1 on top of every £4 saved. The bonus takes it up to £5,000 a year.

That’s a helpful 25% bonus and a real incentive to encourage younger people to save more at a time when the average first-time buyer has to find a deposit of nearly £33,000 just to get a foothold on the property ladder.

But there is a sting in the tail if you are considering taking one out, assuming you are eligible to do so (that is, you’ve not yet reached the ripe old age of 40 by April 2017).

You need to use the proceeds to buy your first home or take your savings after age 60 to keep your bonus and take the proceeds tax-free. Otherwise there’s a 5% exit penalty and charges, as well as a loss of growth on the added bonuses.

Look behind the headlines

But there are real concerns that some of the post-Budget news headlines could encourage some younger savers to think a LISA is their best option and choose it over their workplace pension. If they do that, they could be making a costly mistake.

Anyone considering this approach should bear in mind that a workplace pension contribution benefits from tax relief at 20, 40 or 45% as well as an employer contribution on top; and far more can be put in – up to £40,000 annually.

All things considered, a workplace pension is still the most tax-efficient way to save for retirement.

The good news is that anyone who has already maximised their pension funding options could save an extra £5,000 towards their retirement in a Lifetime ISA from 2017, as long as they’re eligible.

Savings options at a glance from 2017: How do they compare?

When it comes to saving, our table shows how pensions, ISAs and the new LISA stack up.

  Pension Lifetime ISA (LISA) ISA
Savings limits and incentives:
Maximum annual saving (including incentives/ tax relief) 40,000 5,000 20,000
Government incentive 25% of net contribution,

plus tax relief at higher rates if applicable

Up to £1,000 None
Earnings requirement? Yes No No
Employer contributions allowed? Yes No No
Saving via salary sacrifice? Yes No No
Investment growth Tax free Tax free Tax free
Impact on other saving Additional to your ISA subscription Part of your ISA subscription Reduced by LISA saving
 
Age milestones:
Minimum age to open an account 0 18 18*
Maximum age to open an account 75 40 None
Govt. incentive/tax relief received until what age 75 50 N/A
Age you can  access funds without penalty 55 60 or on purchase of first home Anytime
 
Cost of ‘exits’:
Tax on ‘allowed’ withdrawals 25% tax free, balance at member’s rate of income tax Tax free Tax free
Penalty on early withdrawal Unauthorised payment charge (unless it’s on grounds of ill health) Loss of Government incentive (bonus) and any growth, plus 5% charge on the amount withdrawn (unless towards purchase of first home) None
On death before 75 Can be inherited tax free by anyone Can be inherited tax free by spouse or civil partner; otherwise there’s potential for IHT at 40% Can be inherited tax free by spouse or civil partner; otherwise there’s potential for IHT at 40%
On death after 75 Can be inherited by anyone, but taxed at the beneficiary’s rate of income tax Can be inherited tax free by spouse or civil partner; otherwise there’s potential for IHT at 40% Can be inherited tax free by spouse or civil partner; otherwise there’s potential for IHT at 40%

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This article is based on current tax legislation as of April 2016. Tax rules can change and tax treatment depends on an individual’s circumstances.