Heading towards the big 4-0? It may be time to consider the Lifetime ISA (LISA)
Since the Lifetime ISA (LISA) was introduced in 2017 I’ve been really dubious about it.
The product itself is complex and a weird hybrid of an ISA and a Pension, with heavy penalties for early access and not quite as tax advantageous as a pension, but, if you are heading towards 40 (like me!), have brought your first home already and you want to get the most from your savings and tax relief, now may be the time to act. It’ll also be of particular benefit if you have maximised your pension contributions in the tax year.
What is a LISA?
A LISA is a savings account that enables you to save up to £4,000 a year without paying tax on the money you put away.
You benefit from a government bonus of 25% of everything you save, i.e. up to £1,000 a year. The money can be used to buy a first property or be put towards retirement from the age of 60.
You must open a LISA before you are 40 and will continue to receive the bonus until age 50.
Therefore, it is possible to earn a total of £32,000 in bonuses if you pay in the maximum £128,000 over 32 years from age 18. Or, if like me, you start now just before 40 – £10,000.
Accounts can be held in cash, or stocks and shares.
How do the tax breaks work and how is it different to a pension?
You don’t receive tax relief on money paid in and unlike a pension your employer is unable to contribute. However, like a pension a LISA will offer a government boost on the sum you save – free money to you!
The bonus is equivalent to basic rate tax relief on a pension and you get interest or investment growth on top of that. You will not pay tax when drawing retirement income, compared to a pension on which you pay tax at your personal rate aside from a 25% tax-free lump sum.
In terms of tax benefits, pensions are a clear winner for higher rate taxpayers. You receive 40% tax relief on pension contributions, more than the bonus of 25% given for saving in a LISA.
If someone paying tax at 40% pays £4,000 into a pension, the government boosts this to £5,000 with basic rate relief, and a further 20% tax rebate is given on completing a tax return.
However, you are limited with contributions to your pension in line with the annual allowance – which is limited to 100% of your earnings or £40,000, whichever is the lower figure. Anyone earning over £150 000 is limited to pension payments of only £10 000 pa so a LISA contribution will allow tax free savings of another 40%.
What about the rules?
The maximum you can pay in each year is £4,000, coming out of your £20,000 annual ISA allowance.
A pension can be drawn after the age of 55, but with a LISA you have to wait until 60 if you want to keep the bonus and avoid the penalty – unless you’re using the cash to buy a first home.
In theory, LISAs are more flexible given that you can access your funds before retirement if you wish. However, there is a massive penalty if you wish to make an early withdrawal. If you take out money before 60 and do not use this to buy a first home, you pay a 25% penalty. This isn’t just the government taking back the bonus, but a large amount of the growth on your savings too – so it’s only for those who can commit the money.
For example, say you save £4,000 in a LISA over a year, receiving the £1,000 boost for a total of £5,000. If you cash this in you pay 25% of this total, or £1,250. The penalty applies except in the case of terminal illness or death.ProsCons· Benefit from tax uplift by way of bonus· Heavy penalties for access before age 60 (unless for first home purchase)· Extra money saved in a tax efficient environment if pension savings are limited by annual allowance or lifetime allowance· Retirement age of 60, 5 years later than a normal private pension· Can contribute up to £4,000 each year· Uses some of your standard ISA allowance· If you are a basic rate payer and self-employed, you might want to consider one as you can pay into an account when it suits, giving you some flexibility if your earnings fluctuate
· Not available after age 40
Not just for those approaching 40!
LISAs are available from age 18-40 and may form an excellent addition to the more regular ISA and pension savings we are all used to. Everyone’s situation is different and bespoke advice is required to ensure you use the best solution for you.
However, if you are approaching 40 and have maximised the other savings allowances available to you, make sure you get a LISA before the option is gone! There’s also talk of the government scrapping the LISA – even more reason to take out a LISA now – even if you only benefit from the bonus uplift for a few years.