Should I get a Lifetime ISA?

The Tax year has already started, but it’s not too late to start thinking about investing in a Lifetime ISA.

In this article, we’ll be considering the pros and cons of getting a Lifetime ISA and who it’s right for, however for those who are not quite sure what an ISA is – I’ll start with a summary.

What is an ISA?

ISA stands for ‘Individual Savings Account’ and is essentially a tax-free account which you can put money into each year to protect it from the tax man. The amount of money you can put in called the ‘ISA limit’ and from April 2018 it has gone up to £20,000 per year. ISA limits can’t be exceeded, and withdrawals are not taken into consideration. For example, if you put in £20,000 over the year and then withdrew £8,000 you would not be able to put in another £8,000 until the new tax year, as you have already used your limit.

There are two different options for how you use your ISA to save. The first and most common way is to use it like a normal savings account, paying money in and accumulating interest over the year (the interest is tax free).

The second option is to open a ‘Stocks and Shares’ ISA. This is where it can make a big impact on the amount of money you accumulate each year, as you can invest in Shares or Mutual Funds and pay no tax on the profit you make from either a rise in share price or dividend payments. This is great, because if you use a normal non-ISA Fund & Shares account you would pay Capital Gains Tax (CGT) on any profit you make above £11,850 from selling your holdings, and Dividend payments would be subject to Income tax.

I personally don’t have a Cash ISA as interest rates are still too low in the UK to make it an attractive offer for me. I do however have a Stocks & Shares ISA with Hargreaves Lansdown which I pay into each month and has saved me a lot of money over the last few years.

What is a Lifetime ISA?

Now we have covered what an ISA is, let’s move onto Lifetime ISAs! The UK government launched the Lifetime ISA in 2017, for those saving for a First Home or Retirement. As with a normal ISA, you can also choose to invest in either Cash or Stocks/Shares, and all interest, profit, and dividends are exempt from taxation.

£4,000 can be payed into a Lifetime ISA each year and it comes out of your overall annual ISA Limit. For example if you pay in the maximum £4,000 into your Lifetime ISA, you can only pay £16,000 into another Cash, or Stocks & Shares ISA. However, the real benefit of the Lifetime ISA is the UK Government gives you an additional 25% on whatever you pay in. This means if you save the maximum £4,000 annually (£333 per month), then you will receive an additional £1,000 paid in by the Government, taking your savings up to £5,000 for the year!

This may make it sound like a very attractive offer, however there are also many terms and conditions which are important to consider before making the investment. The main condition an investor needs to be aware of is a 25% fine applies if the money is withdraw for anything other than a first house, unless they are over the age of 60. If you are 60 or over you can withdraw all the money tax free and use it how you wish.

You may be thinking, ‘oh well that’s fine, they are just getting their 25% back’, but this is not the case. For example, if you had £5,000 in your account (the £4,000 you saved plus the bonus £1,000) and you decide to take it all out. Fines are calculated at 25% of the total amount in the account, coming to £1,250. Down £250 from the original investment put in.

Now we have got the big condition out of the way, let’s look at the other need-to-knows for both First-time Buyers, and those saving for retirement.

Lifetime ISA for First-time-buyers

1. You must be buying a UK residence to live in, costing £450,000 or less.

To qualify for the scheme, you need to be purchasing a UK residence that you plan to live in. If you are a first-time buyer but are looking to invest in a Buy-to-let property then you will be exempt. A 25% fine applies on properties costing over £450,000.

2. To open a Lifetime ISA you need to be over 18 and under 40

You can pay money into your Lifetime ISA until you are 50, but the cut off for opening an account is 40. The logic being that you are too close to retirement after this age.

3. A Lifetime ISA can be moved between providers

As with a normal ISA, interest rates will go up and down on Lifetime ISA accounts. So if you spot a better deal with a different provider, you are free to transfer your account. You can also switch between a Stocks and Shares and Cash Lifetime ISA if you want to.

4. If you are purchasing a house with a partner who has already owned a property previously, you can still purchase using a Lifetime ISA.

An ISA is an individual product, so providing you have never owned a house you can use it to purchase a property. Even if you are purchasing with partner who is not a first time buyer. It simply just means you can use your Lifetime ISA to cover your part of the deposit, however they won’t be able to for their contribution.

If you are both first time buyers the benefit is you can both save £4,000 each a year (£8,000 total) and get a £2,000 bonus. Which means you will be able to save quicker.

Couple 1 Couple 2
First-time Buyer? Yes No Yes Yes
Can use Lifetime ISA to buy new home? Yes No Yes Yes

 

5. The Lifetime ISA offering does beat a Help to Buy ISA, but it has more restrictions

You can have both a Lifetime ISA and a Help to Buy ISA, but you can only use the bonus from one when purchasing a home. Here is comparison so you can see what works best for you:

LIFETIME ISA HELP TO BUY ISA
Max contribution? £4,000/yr £2,400/yr (£3,400 in year one)
Can you pay in a lump sum? Yes No, need to save monthly
Max bonus? £33,000 (assumes max contribution every year from 18-49) £3,000 (assumes max contribution over four years and eight months)
When’s the bonus paid? Monthly On completion when you buy a home
Investment option too? Yes, via stocks & shares Lifetime ISA No. Cash savings only
Max property price? £450,000 £250,000 (£450,000 in London)
How quickly can you use it? After the Lifetime ISAs been open 12 months Once you’ve £1,600+ saved (can be done in min 3 months)
Who can open it? Anyone aged 18 to 39 Any first-time buyer aged 16+
What can it be used for? It can be used both for the mortgage deposit and the home deposit (if it’s a new build) Just the mortgage deposit
Can I withdraw money if not buying a home? yes if you are over 60, otherwise you will be hit with a 25% fine Yes at anytime, you just won’t get the bonus

 

Lifetime ISA for Retirement

For those at the far end of the Lifetime ISA age eligibility (39), their 60th Birthday is still 20 years away. The rules may change within this time (for good or for bad). But here is a summary of the key points as they currently stand:

  • You can access the money on or after your 60th Birthday
  • Withdraw money in instalments, or as lump sum.
  • All money taken out will be tax free
  • Lifetime ISA savings impact Means Tested Benefit assessments (Pensions are excluded).

But does the Lifetime ISA offer a better solution for retirement vs a Pension?

No. Except for Self Employed basic rate taxpayers. See the table below for a comparison:

LIFETIME ISA PENSION – BASIC-RATE TAXPAYER PENSION – HIGHER-RATE TAXPAYER
Employer contribution None 3% with auto-enrolment 3% with auto-enrolment
State contribution 25% 25% (tax relief) 66% (tax relief)
Max amount you can you save/yr? £4,000 £40,000 (max amount with tax relief) £40,000 (max amount with tax relief)
When is bonus/tax relief paid? Monthly Immediately 25% paid immediately, rest must be claimed
Who can open one? Anyone aged 18-39 Anyone aged 16+; parents can open one for you from birth Anyone aged 16+; parents can open one for you from birth
When can you access it? Age 60 (accessible before for a 25% penalty) Age 55 Age 55
Do I pay in from pre or post-tax income? Post-tax income Pre-tax income Pre-tax income
What tax will I pay on withdrawal? Tax-free 25% tax-free, rest taxed at your income tax rate 25% tax-free, rest taxed at your income tax rate
Liable for inheritance tax? Yes No No
Affects pre-pension-age benefits entitlement? Yes No No
Can be taken to pay creditors in bankruptcy? Yes No No

 

Conclusion

Looking at pros and cons, a Lifetime ISA is an absolute no-brainer if you are a first-time buyer. The extra 25% will drastically improve the rate at which you can save for a deposit. Especially if you are buying with a partner who is also a first-time buyer. If you are saving £4,000 each a year then you will accumulate an extra £2,000 in bonuses which is fantastic.

For retirement it is not so straight forward, as the amount you can save is inferior to what you would get with a pension. However a Lifetime ISA does offer slightly more flexibility and control over the money you are saving.

It’s still 20 years before anyone can start to withdraw their money. This is something to be wary of, as rules can change dramatically over that time. 


 

After writing the main article I have had a number of other questions from people. So I have added them below with answers:

 

Q. Do Dividend payments paid directly into my Bank account?

A. Unfortunately not, with a Lifetime ISA all dividend payments will stay within the account until you are over 60. However you are free to invest the dividend cash, providing you keep it in your account.

 

Q. Before i’m 60 can I take out a bit of the money and keep the rest in the ISA?

A. No. You must either touch none of the money or withdraw all of it. However, this will subject you to the 25% fine (unless you are over 60).

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