Five people who should consider a Lifetime ISA

The influential Treasury Committee has launched a call for evidence on how the Lifetime ISA could be reformed, with the questions ranging from whether there are improvements to be made to the account all the way through to whether it should be scrapped altogether.

There’s no denying that the account is more complicated to explain than a standard ISA, with its dual purpose for saving for a first home and for retirement meaning it can appeal to two very different groups of people. However, with the 25% government bonus the product is unbeatable for many wannabe homebuyers, while also providing a good incentive for some pension savers.

More than 750,000 people paid into a Lifetime ISA in the 2022/23 tax year, with just shy of £1.9 billion paid into the accounts, according to figures from HMRC, showing how popular they are. Here are five groups of people who should consider using a Lifetime ISA.

1. The self-employed pension saver

The Lifetime ISA is an attractive pension option for anyone paying basic-rate tax. While employed people would be better off maximising any company matching on offer for their pension, self-employed people don’t have this option. The 25% government bonus on offer is effectively the same as tax relief in a pension for basic-rate taxpayers up to the £4,000 limit, but Lifetime ISA funds have the flexibility to be withdrawn early (albeit with an exit penalty that means you might get back less than you put in) and completely tax-free after age 60. Pensions, on the other hand, generally can’t be touched until you reach age 55 and only 25% of the fund would not be subject to income tax.

However, savers have to bear in mind the age restrictions on the account – you cannot open it after your 40th birthday and you cannot pay into it (or receive a bonus payment) from age 50.

Looking at the numbers, someone who pays in £4,000 a year from age 18 to 50 into either a Lifetime ISA or a SIPP will receive exactly the same amount of government bonus or tax relief (£32,000). If we assume 4% annual investment growth after charges, both will have built a healthy looking fund worth £326,000.

Based on today’s tax rates, someone who took an ad-hoc lump sum of £20,000 from their pension at age 60 would pay £486 in tax (assuming they had no other taxable earnings). The same investor would pay no tax at all on their Lifetime ISA withdrawals.

The difference in tax paid expands as the withdrawals get bigger. If the entire fund was withdrawn at once (not an advisable retirement strategy in most cases), the pension investor would pay a whopping £96,228 in income tax, whereas the Lifetime ISA saver would pay nothing.

2. The first-home buyer (who won’t be priced out)

For anyone saving for their first home, the Lifetime ISA is pretty unbeatable with the 25% government bonus boosting your deposit savings. If you pay in the maximum £4,000 per year, you’ll get a juicy £1,000 bonus from the government – giving an immediate 25% top-up to your savings. Because the government bonus is typically paid in almost immediately you also get the benefit of interest or investment growth on that money too – which will compound over time.

If you had saved £4,000 into a Lifetime ISA for each of the past nine tax years since the account was launched and had seen 4% investment growth a year, you’d have a pot worth £48,000. However, if you’d saved that same amount of money in a standard ISA, still earning 5% return a year, you’d have a pot worth just over £38,000. That means by shunning a Lifetime ISA you’d be £10,000 worse off.

However, the property limit for the Lifetime ISA is £450,000 and has remained at that level since its launch in 2017 with no signs of it increasing, despite many calls for it to do so. As house prices have risen dramatically during that time, some savers may find themselves priced out of using the Lifetime ISA. Those starting out on their house-buying journey also can’t bank on a future increase to the property limit, so they need to consider what house prices may be when they come to buy and whether they will be buying within the limit.

3. The undecided nearing their 40th birthday

Because of the age limit on the account, once you hit your 40th birthday you can no longer open a Lifetime ISA. Anyone nearing this milestone birthday should think about opening an account and funding it with a small amount of money, just so they have the option of using it in the future. You can pay into the Lifetime ISA up until the age of 50 – and get the government bonus until that point too. Then the account can remain invested but with no further contributions into it until the age of 60 when you can withdraw the money tax free. You might have already bought your first home and have a pension with your employer, but you don’t know what the future might bring and so it could be smart to open the account so you could use it in the future.

4. The Help to Buy ISA saver who has reached their limits

Help to Buy ISA accounts are now closed for newcomers, but many people still have the accounts open and their deposit savings in there. However, they may be better off moving to a Lifetime ISA for a couple of reasons.

First, the property limit. With the Help to Buy ISA you can use it on a property worth up to £450,000 in London, but only on a property worth up to £250,000 outside London. This has proved a problem for some outside of the capital. With the Lifetime ISA there is a limit of £450,000 regardless of what area of the UK you’re buying in. So if you’re priced out of the Help to Buy ISA, you could transfer to a Lifetime ISA.

Second, the maximum government bonus. Both the Help to Buy ISA and Lifetime ISA get the same 25% government bonus, but with the Help to Buy ISA this is limited to the first £12,000 saved – meaning a maximum bonus of £3,000. With the Lifetime ISA you can get up to £1,000 a year in government bonus, up until the age of 50. If you opened a Lifetime ISA at age 18, that is a maximum government bonus of £32,000. If you’ve maxed out your Help to Buy ISA bonus and still have more to save, you could switch to a Lifetime ISA.

However, any transfers from your Help to Buy ISA count towards your Lifetime ISA annual limit of £4,000 – so if you have a chunky amount in your Help to Buy ISA you’ll have to transfer it over multiple tax years. But with the new tax year looming you could move £4,000 now and another £4,000 in a few months’ time.

5. The mega pension saver

Lifetime ISAs are also a good option for those who have maxed out their pension savings but still want to put away more for retirement. The pension annual allowance has increased, so most people have £60,000 a year they can put into their pension (assuming they have sufficient earnings), plus any unused allowances for up to three years. But some high earners will have a lower limit, thanks to the tapered annual allowance. Either way, if you’ve hit your annual pension allowance you might want to use the Lifetime ISA to squirrel away up to £4,000 a year extra for your retirement savings.