Launched in April 2017, the Lifetime ISA is a new type of tax-free savings and investment account that helps you buy your first home and save for retirement.
What is a Lifetime ISA?
A Lifetime ISA (LISA) allows you to deposit up to £4,000 a year into a savings account between the ages of 18 and 50. At the end of each year, the government gives you a 25% bonus – that’s an extra £1,000 if you deposit the maximum amount. That’s a lot of free money when you set aside £4,000 a year.
If you retire from a lifetime ISA (also known as a retirement ISA) to get a mortgage on your first home, you can continue to use it for a second purpose: saving for retirement. With young people motivated to save for their first home but less motivated to save for retirement, the government hopes combining the two will make them more likely to save for retirement.
Like other ISA products, you can have a lifetime cash ISA that earns guaranteed interest — or you can have a stock and share LISA where your savings can generate gains or losses.
LISA is part of your total ISA allowance. So if you deposit the maximum LISA amount of £4,000, you can still deposit an additional £16,000 into other types of ISAs.
Why Get a Lifetime ISA?
Lifetime ISAs are designed to help you save for your first home, retirement, or both.
It can be used to buy a property with your partner, potentially doubling your 25% state bonus if you both meet the eligibility criteria. If one of you already owns the property, the other can still use the lifetime ISA.
A Lifetime ISA can also be used to save for retirement, but you cannot use your LISA funds with impunity until you turn 60. You can open a Lifetime ISA between the ages of 18 and 39 (however, you can continue to open a LISA until you turn 50).
At this point, you can take your funds and use them for whatever you want. You don’t have to withdraw the entire amount, you can withdraw part, and all withdrawals are tax-free. Any remaining funds will continue to earn interest or investment gains or losses.
You should not rely solely on a LISA to save for retirement, as this is not the same as saving for an autoenrollment or other company pension plan. Saving through an annuity can give you additional “free” money through employer contributions and state tax deductions that you wouldn’t get with a lifetime ISA.
A lifetime ISA works the exact opposite of regular retirement savings because you pay income taxes before you put the money into the LISA — however, LISA withdrawals are tax-free, whereas retirement annuity payments are taxable income.
If you’re self-employed — and therefore don’t have an employer paying your pension — a Lifetime ISA is an attractive way to save for retirement.
How to use a lifetime ISA
There are no penalties if you use a Lifetime ISA to buy your first property or withdraw funds at or after age 60. If you want to spend the money on something other than your first property, and you’re under 60, you’ll face a 25% withdrawal penalty.
The only other situation where there is no penalty for leaving is if you are terminally ill and have less than 12 months to live. If you die, your LISA ends on the day you die and there are no withdrawal fees.
When buying a property, you must be a first home buyer who has never owned a home in the UK or anywhere else. The property must cost less than £450,000 and be a UK residential property.
You must amortize the mortgage to buy and live in the property, so it cannot be rented out or used as a holiday home.
When purchasing a property, your lifetime ISA provider must pay the funds directly to a trustee or attorney. Your LISA must be open for at least 12 months to be able to withdraw money to purchase your first home.
You will be charged a withdrawal fee if you choose to transfer your Lifetime ISA to another ISA type, but not if you transfer to another Lifetime ISA provider.
Withdrawals can be expensive as not only will you lose your winnings, but you will get back less than what you wagered. For example, if you invest £8,000 over 2 years and receive £2,000 in government bonuses, you will have £10,000. If you quit early, you’ll lose 25%, or £2,500 – so you’ll only get back £7,500 and lose £500 or 6.5% of your investment.
All winnings are exempt from income and capital gains taxes. You can open multiple lifetime ISAs, but only one can be opened and deposited per tax year. You can switch between different lifetime ISAs without affecting the annual ISA limit.