Five years of the LISA (Lifetime ISA) – What you need to know

Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, describes the history of the Lifetime ISA, or the LISA, and specifically what you need to know about them after five years.

Covered in this article:

How do LISAs work?
What’s the catch?
Who benefits from using a LISA
How does it differ from a Help to Buy ISA
How popular have they been?
Where do people invest in a LISA?

Helen Morrissey introduced the article by saying:

“Over half a million people have opened a LISA since they were introduced almost five years ago, and among HL clients alone, more than 5,000 have used them to realise their dream of home ownership. The average age of our LISA holders is 31 years old and given that this is the same as the average age of a first-time buyer, it would seem that a fair number have opened a LISA for retirement. It’s particularly useful for self-employed people, who are not currently covered by auto-enrolment and so are less likely to have a pension – for this group the LISA can play a critical role in their retirement planning.

“However, LISA holders face challenges. While the 25% government bonus is generous the 25% penalty for withdrawing money from a LISA means the holder loses not only their bonus but a chunk of their savings too. We would ask the government to look at re-instating the 20% penalty it introduced between 6 March 2020 and 5 April 2021, so this doesn’t happen.

“In addition, the £450,000 limit on the home that can be purchased with a LISA is looking incredibly squeezed for people living in London and they face penalties that again will take a chunk out of their hard-earned savings.”

What is a LISA and how does it work?

The Lifetime ISA (LISA) was introduced in April 2017 to help young people struggling to save for retirement while trying to buy their first home.

People between the age of 18-40 can contribute up to £4,000 to their LISA every tax year and in return they get a 25% bonus. You can withdraw money tax-free to buy your first home any time after the first year you hold a LISA.

You can also contribute to your LISA until the age of 50 and withdraw money tax-free from it without paying a penalty from the age of 60.

Contributions to your LISA form part of your annual ISA allowance, so if you are contributing to other ISAs then be sure to keep track of how much you have put in as you face a tax charge if you breach your £20,000 ISA limit.

LISAs are also very tax efficient. You won’t pay income tax on any savings that grow in excess of the personal allowance and if you have a stocks and shares LISA you don’t need to worry about paying dividend or capital gains tax.

So, what’s the catch?

The purpose of a LISA is to help people save for their first home or for retirement. If you take money out for any other reason you will incur a 25% penalty. While it may look like you are just giving up the government bonus it’s more complicated than that.

If you put £4,000 into your LISA, you would receive the 25% government top up which brings the sum of your LISA up to £5,000. If you then withdraw that £5,000 you will pay 25% on that which comes to £1,250 so you are eating into your savings.

Last year the government temporarily reduced the LISA penalty to 20% in response to the pandemic. Despite this a recent FOI showed £34m was paid in penalties last tax year – more than three times the amount paid in the previous tax year. Our own client data shows 8221 clients have paid a penalty to withdraw. The government has since reinstated the 25% penalty.

A second issue is that people can only use their LISA to purchase a home worth £450,000 or less. If your dream home costs more than that, again you get hit with the penalty. Recent ONS data showed the average first time home cost people outside of London is £222,997 on average but for those wanting to buy in the capital they have significantly less headroom with average first-time house prices at £444,592.

Who benefits from using a LISA?

Having a LISA and benefiting from the government top up can really boost your home deposit saving and even if you already contribute to a pension, a LISA can be a good alternative vehicle to supplement your retirement planning.

Self-employed people may find them particularly beneficial in that they don’t benefit from auto-enrolment where they automatically contribute to a pension and receive a top up from their employer.

It can play a vital role for employed people too. The impact of the 25% bonus on a LISA is the same as basic rate tax relief on a pension, and all the income is tax free. It means that anyone who is a basic rate taxpayer now, and expects to be so in retirement, who has already taken as much advantage of employer contributions as they can through their workplace pension, could use a LISA for the next chunk of their retirement savings – assuming they’re the right age to qualify.

While you can’t open a LISA after the age of 39 or contribute to it after the age of 50, the contributions you made will continue to benefit from investment growth.

If you currently qualify for a LISA, even if you don’t see how it would work for your circumstances, it’s worth opening a LISA with a minimum amount so you can keep your options open in future.

How does it differ from a Help to Buy ISA?

Both LISAs and Help to Buy ISAs were designed to help people get on the property ladder. While Help to Buy ISAs closed to new applicants in November 2019, if you already have one you can continue to save into it until 30 November 2029.

Both products attract a 25% government bonus, but while the maximum contribution to a LISA is £4,000, for a Help to Buy ISA (after the first year) it’s £2,400 – and it has to be paid into monthly. And while the Help to Buy ISA is only for cash savings, you can choose between a cash LISA or a stocks and shares LISA. Also, while the home you purchase with a LISA must be worth £450,000 or less this is the case wherever you are in the country. A Help to Buy covers first homes worth up to £450,000 in London but £250,000 elsewhere.

How popular have they been?

Since their launch LISAs have grown steadily. The latest data from HMRC showed 154,000 LISAs were subscribed to in 2017/18. Provisional figures showed this had grown to 545,000 in 2019/20. While LISA holders are currently too young to be making withdrawals for retirement, we have seen 5258 of our clients making a house purchase withdrawal from their LISA.