Investors looking to buy their first home or save for retirement can now put their money in a Lifetime ISA (LISA) and be rewarded with a 25% bonus from the government on top of their savings. Although investors could get the equivalent of £32,000 free cash, the new LISA has been controversial.
What is the LISA?
The LISA is a new tax-free savings account designed for those wanting to buy their first home or save for retirement. If you’re under the age of 40, you can put up to £4,000 in your LISA each year and receive a 25% top-up from the government – that’s £1,000 if you’ve invested the full amount. This means investors can get up to £32,000 on top of what they’ve already saved.
On the face of it, this is much more generous than the current Help to Buy ISA. Savers can also get a 25% bonus on their savings, although the government has set its bonus limit at £3,000.
The 25% government LISA bonus will be paid monthly from 2018/19 to allow savers to benefit from compounding – when your asset’s earnings are reinvested to generate their own earnings. You’ll be able to pay into your LISA up to the age of 50, although you won’t have access to your retirement pot until you’re 60 – unless you buy a house.
Just like the traditional ISA, money can either be saved as cash or invested in stocks and shares. With interest rates still in the doldrums and inflation running higher at 2.3%, anything you keep in cash is likely to have less purchasing power in the future.
So stocks and shares currently offer higher potential returns to those willing to take on more risk, especially if kept for a longer period. Any profit and income made on your LISA investments will be protected from tax as part of your annual £20,000 tax wrapper.
The LISA has been controversial due to its plans to penalise savers if they need to access their cash early. This savings pot can only be used to buy a first home or for retirement at the age of 60, otherwise it’s locked up. If a saver needs to urgently access their savings, they’ll have to pay out 25% of the amount withdrawn as a penalty – which includes the bonus, any income generated on that bonus and a fee.
This will see investors get less than they put initially put in. For example, your £1,000 initial investment is topped up with a £250 bonus from the government. If you want to withdraw this £1,250 early, you will be charged a 25% penalty: £312.50. This means you will only get back £937.50.
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Investing in a stocks and shares LISA can be a no-brainer if you’re saving for your first home and can wait 12 months to get your cash back. But the rules are complicated and investors need to understand the small print to ensure they don’t lose out. Many have warned this could provide a backdrop for the next mis-selling scandal.
To make sure you can use your LISA to buy your first home, the house needs to be worth under £450,000. If you’re buying with someone, you can both use your LISA if you’re both first-time buyers. If not, the person who already owns part of a home will be charged for withdrawing their bonus.
If you’ve already been saving in a Help to Buy ISA, you can transfer your balance into your LISA this financial year without it affecting your £4,000 allowance. Otherwise, you can only use the bonus from one towards your first home.
After recent pension freedoms saw exit charges reduce to 1%, the 25% charge looks a massive disadvantage, especially when you can usually take 25% of your pension as a tax-free lump sum at 55. Whilst investors will be saving for retirement, the complicated LISA isn’t a specific pensions product.
The current government contributions to pension savings can be more generous depending on your income tax bracket – higher rate tax payers can receive a higher percentage from the government in a pension than a LISA. You can effectively get your income tax back on the amount saved into a pension; for example, to save £100 a basic rate tax payer only needs to pay in £80, whereas a higher rate tax payer only needs to pay in £60. In a LISA you’d need to pay in £75.
Why aren’t we offering the LISA?
We know accessing hard-earned cash is important to investors, especially those with families. With the Moneyfarm Stocks & Shares ISA, our customers can access their money within five working days.
Whilst we advocate the benefits of long-term investing, we don’t want to penalise those who are forced into using their rainy day funds for just that – a rainy day. Knowing your investments balance risk and return is one thing; knowing you’ll get less than you put in if you’re forced to use it early is quite another.
Just because we aren’t offering the LISA product to our customers, doesn’t mean it’s not the right product for you. If you’re unsure, talk to your adviser.