How should you use the new lifetime ISA?

Posted on April 3rd, 2017 | Categories - Investments, Savings

They say that an ISA is for life, not just for Christmas. Or is that a dog? Regardless, that’s the case for the new Lifetime ISA.

The Lifetime ISA (shortened to LISA in this article for your own sanity) will be launched on the 6th of April 2017. It is a saving scheme that will be partially funded by the Government, and this article will delve deep into exactly how it can be used:

  • First house purchase?
  • Retirement?
  • Both?

So, who or what exactly is LISA?

The LISA is the latest addition to the ISA family, having the familiar tax-free wrapper of an ISA. It has a few quirks that make it beneficial for some, but about as useful as a handbrake on a canoe for others.

The key points of a LISA are as follows:

  • Over 18s and under 40s (on 6th April 2017) can open an account
  • You can save up to £4,000 each year
  • The Government will add 25% to your contribution, so somebody investing £4,000 will receive an additional £1,000
  • If you don’t use it to buy a first home or for retirement you will incur a penalty
  • Available as a Cash or Stocks & Shares LISAs

Whilst the money you save could technically be used for something other than a first house or your retirement, you would forfeit the money that the Government has contributed. Any interest accrued would also be taken away in the form of exit penalties, making it a very inefficient way to save if you do access the money early.

The £4,000 cap is taken out of your annual ISA allowance, which for the 2017/18 tax year will be £20,000. This means you can contribute up to £16,000 to a different ISA.

So, with this all in mind, is the LISA a viable way to climb your first rung on the property ladder?

Buying a first home

The LISA was announced in the 2016 Budget as the ideal product for helping the Millennial generation buy their first home. A 25% Government top-up will be a much-needed boost for many first-time buyers, especially with the average deposit needed to buy a first home now £32,321 (source: Halifax).

The rules for buying a first home with a LISA are as follows:

  • The house must cost under £450,000
  • You must have held an account for over 12 months
  • You must be a first-time buyer and take out a mortgage

Because a LISA is still an Individual Savings Account, it means that if you are buying a house with a partner or spouse, you can effectively double up your savings. That is, of course, providing they are first time buyers too. If one of you is already a home-owner, then only one LISA will be permitted.

For some, particularly those living in London and the South East, a major advantage of this account will be the difference in house price limits. A Help to Buy ISA currently allows a maximum house price of £250,000 outside of London and £450,000 within it. With the average UK house price currently £218,255 (source: Land Registry Price Index) and rising each year, it will allow people more choice of where to live.

How long will it take to buy a home with the LISA?

A recent report by AJ Bell shows several examples of how a person could reach the £32,321 average deposit amount.

With a personal contribution of £4,000 each year, a saver could reach £35,646 in six years with an Equity LISA returning 5% per year; there is of course no guarantee that such a return would be achieved, it could be higher, it could be lower. A Cash LISA returning 1% per year would reach £31,057 with the same personal contribution, leaving the first-time buyer just short of their target in six years.

£4,000 per year is admittedly a hefty sum to save for some young people. With a lower personal contribution of £2,000 each year, a saver could reach £32,878 in 10 years with an Equity LISA returning 5% per year. A Cash LISA returning 1% per year would reach £32,018, just shy of the target, in 12 years.

Can a LISA compete with a pension?

For some people yes, for others no.

There are advantages and disadvantages to both options. A pension can be accessed at the age of 55, whereas a LISA can’t be touched, without penalty, until you are 60. The first 25% of a pension can be taken tax-free. A LISA is protected by the usual ISA tax wrapper so the whole sum is tax-free.

An example from AJ Bell shows how a LISA, a workplace pension and a personal pension, can turn personal contributions of £800 per year into pension pots that differ widely. The example considered a saver starting at 25, contributing until 65, with an assumed annual growth rate of 5% and a salary of £20,000.

The LISA and the personal pension faired the same, with a final pot of £126,840. However, the workplace pension eclipsed them both, growing to £202,944. The advantage of an employer paying into a pension is worth a staggering £76,104.

So, does this make the LISA a viable retirement option?

To certain groups, yes, for others, no.

  • Anyone with access to a workplace pension should join it in preference to using a LISA simply because the former benefits from an employer contribution, which the LISA does not
  • Anyone without access to a workplace pension, perhaps because their earnings are low, should consider the advantages and disadvantages of both the LISA and a personal pension
  • Self-employed people won’t have access to a workplace pension, again, they should, age permitting, compare the LISA with a more traditional pension option

No-brainer for first time buyers

Whilst the pros and cons of a LISA for retirement planning depend on your own specific circumstances the advantages are clearer for first-time buyers.

If you are eligible and definitely plan to use your savings for a deposit on your first home, why wouldn’t you use the LISA? The government top-up will simply mean you reach your target amount more quickly than would otherwise have been the case.

If you would like to discuss the LISA in more detail we are here to help.

Please call us on 0115 933 8433 or email info@investmentsense.co.uk

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