The government is planning to launch a new tax-free savings account in April 2017 with the aim of helping you save for your future. With the release of the help-to-buy ISA last year, how does the Lifetime ISA compare to other options available?
What is the Lifetime ISA?
Like other ISAs, the Lifetime ISA is a tax-free saving vehicle. The aim of the product is to help people save flexibly for the long-term throughout their lives. It can be opened from age 18, and contributions of up to £4,000 a year before their 50th birthday will receive a 25% bonus from the government (up to a bonus of £1,000 a year). So a saver, over their lifetime, could have contributions of £128,000 with a government bonus of £32,000.
The savings and bonus can be used towards buying a first home worth up to £450,000 at any time, or can it can act as a retirement fund, with the promise that all withdrawals after age 60 would be tax-free.
Who can have one?
Anybody aged 18-40 who is a UK resident can open a lifetime ISA. Unlike the help-to-buy ISA, it is possible to open a Lifetime ISA, Cash ISA and Stocks & Shares ISA all in the same tax year. The Lifetime ISA can be invested in Stocks & Shares or cash.
In relation to using the funds to buy a first property, the accounts are limited to one per person rather than one per household which means that both partners could open a Lifetime ISA and eventually receive the 25% bonus each towards their first home together.
Are there any terms and conditions?
As with most tax incentives, there are caveats. There is a cap on the value of the property purchased at £450,000. It is possible to use both a help-to-buy ISA and Lifetime ISA, but the bonus will only be available for one or the other for a house purchase. It is however, possible to transfer savings from a help-to-buy ISA into the Lifetime ISA.
If the savings are not used to buy a property, any withdrawals before age 60 will result in the loss of bonus on the withdrawal as well as a 5% penalty charge.
Is the Lifetime ISA worth having?
Saving £4,000 per year and receiving £1,000 from the government is a 25% return before any interest or investment growth, which makes it an attractive prospect. The downside is that the money must go towards buying a first home or kept in the account till age 60 in order to benefit from the government bonus.
The government have also announced that they will increase the yearly ISA allowance from £15,240 to £20,000 in April 2017 and the Lifetime ISA contributions will sit within this limit.
With the pension contribution annual allowance being reduced from £40,000 to £10,000 for many people, the lifetime ISA is a great alternative to save for retirement if you have already paid in the maximum allowance into your pension for the tax year.
Standard Cash ISAs are currently paying interest of around 1.3% and although interest rates for the Lifetime ISA are yet to be announced, the 25% government bonus is already a huge advantage in potential returns. The downside to this is that the Lifetime ISA is not as easily accessible as cash ISAs and therefore savers should consider using both options.
How does this compare with a pension?
In some respects, the Lifetime ISA compares favourably with a pension. They both have effectively the same tax relief for a basic-rate taxpayer (20% tax relief on £4,000 contribution into a pension would boost it to £5,000 – an increase of 25%). However, for higher-rate and additional rate taxpayers, pensions look more attractive with a higher rate of tax relief. The only downside is that the bonus is paid at the end of the year in a Lifetime ISA whereas immediate tax relief is given within a pension.
The main advantage of a Lifetime ISA for retirement purposes is being able to withdraw all proceeds tax free from age 60 onwards. This betters the pension which although it is available from age 55, only 25% is certain to be tax-free. For both cases, it is possible to access the funds before these ages however there are steep penalty charges involved.
Subscription limits on pensions are higher than Lifetime ISAs with an annual allowance of £40,000 (10,000 in some cases) and a maximum lifetime limit of £1,000,000 compared to a £4,000 annual allowance within the Lifetime ISA and a maximum contribution of £128,000 before bonus.
Overall we believe that rather than being a replacement to pensions, the Lifetime ISA holds its place as an alternative tax-efficient savings vehicle. Holding both investment products can help save tax on your income in retirement.
Conclusion
Our initial thoughts on the Lifetime ISA are that it is a good way to save towards to big life goals, a home and retirement in a tax-free environment. The 25% government should not be missed out on. We will provide further updates closer to the time these products are made available on the market.
