GETTING THE MOST OUT OF A LIFETIME ISA
The Lifetime ISA (LISA) was introduced in April 2017 as a dual-purpose investment plan designed to help individuals save for a first home and whilst also providing an additional option for retirement planning. It’s structure and limits have largely remained unaltered since its introduction in April 2017 and in January a Treasury Committee called for evidence asking whether it still remained an appropriate financial product. It’s hoped that the output from this review will lead to design changes that will remove some of the existing barriers that have limited the use of the LISA as a retirement planning vehicle.
What is a LISA?
A LISA is a tax-free savings account designed to help individuals save for their first home or retirement. Investors can contribute up to £4,000 per tax year, with a government bonus of 25% added on top of contributions. This means that for every £4,000 saved, an additional £1,000 is added by the government. Our LISA Stocks & Shares can also be invested in the same variety of assets as a Stocks and Shares ISA.
Withdrawals are subject to a penalty charge, unless they are used for the purchase of a first home, or the funds are withdrawn at age 60. Penalty free withdrawals are also available on terminal illness or death.
Transfers from other ISA products such as a Help to Buy ISA are permitted subject to the £4,000 payment limit.
Eligibility to open a LISA
A client must :
- Be aged between 18 and 40 at account opening
- Be a UK resident for tax purposes (or meets the general residency criteria for ISAs)
- Have not already opened a LISA in the same tax year
- Ensure any monies paid in means they don’t exceed their overall ISA subscription limit.
- Provide a National Insurance number at outset.
First-time buyer qualifying conditions
In simple terms the LISA can be used to purchase a client’s first home if:
- The property costs £450,000 or less.
- The property is purchased at least 12 months after the first payment is made into the Lifetime ISA.
- A conveyancer or solicitor is used to act for the client in the purchase – (the ISA provider will pay the funds directly to them).
- The property is being purchased with a mortgage.
- The investor intends to live in the property as their primary residence (it cannot be for a “buy-to-let”).
But what about retirement planning?
It’s important to understand the differences in tax treatment between LISAs and pensions. For basic rate taxpayers considering whether to fund a personal pension or a LISA, the tax relief received from a pension contribution is effectively the same amount as a LISA bonus (although the LISA bonus is capped at £1,000). In both instances, the government contribution is paid to the provider and added to the wrapper. However, for a personal pension higher rate taxpayers can claim a further 20% relief on the gross pension contribution through their self-assessment and receive the payment outside of the pension wrapper.
Withdrawals from the LISA are always tax-free and are also penalty free from age 60. Typically, a pension will only allow 25% to be paid tax free, the remaining amount will be subject to income tax at the member’s marginal rates.
The table below provides a comparison of the outcomes based on the rates of tax paid by the investor and assuming contributions are paid into a personal pension and qualify for relief at source:
| Wrapper – basic (BRT) or higher rate tax (HRT) | Contribution (Net) | Tax relief /bonus | % Tax free withdrawal | Tax to pay on withdrawals | Net Amount |
|---|---|---|---|---|---|
| LISA | £4,000 | £1,000 | 100% | £0* | £5,000 |
| Pension BRT | £4,000 | £1,000 | 25% | £750 | £4,250 |
| Pension HRT | £4,000 | £1,000 | 25% | £1,500 | £4,500 |
| Pension HRT /BRT | £4,000 | £1,000 | 25% | £750 | £5,250 |
As shown above, the tax-free withdrawals from the LISA present a compelling argument for its use by both basic-rate and higher-rate taxpayers. However, pensions offer a more favourable outcome for investors who are higher-rate taxpayers when making contributions but become basic-rate taxpayers in retirement.
The age at which withdrawals can be made is an important consideration for both wrappers. For LISAs used for retirement, the penalty-free withdrawal age is currently set at 60. In comparison, pensions have a current normal minimum retirement age of 55, which will rise to 57 from April 2028. It is not inconceivable that there may be further convergence in the retirement ages for both products in the future.
Another limitation of the LISA is the requirement for contributions to cease at age 50. However, this is not currently an issue, as the oldest LISA holders will only turn 47 this April. As these early adopters approach age 50, it will be interesting to see whether this provides additional impetus for removing this restriction.
The LISA offers additional flexibility, as funds can be accessed at any age. However, withdrawals are subject to a 25% penalty charge on the value of the withdrawal, which equates to an effective 6.25% penalty (in light of the tax relief offered on the initial contribution). While this may seem like a reasonable price to pay for added flexibility, it can be a double-edged sword for a long-term savings plan.
Regarding death benefits, the LISA follows the standard ISA rules. If the deceased has a spouse or civil partner who meets the qualifying conditions, they can utilise the Additional Permitted Subscription (APS) allowance. However, the £4,000 annual contribution limit still applies if the funds are to be invested in a LISA. While the LISA will typically form part of the deceased’s estate for inheritance tax (IHT) purposes, beneficiaries are not required to pay income tax on payments they receive. Additionally, regardless of the investor’s age at the time of death, the early withdrawal charge does not apply.
In contrast to ISAs—which only allow a spouse or civil partner to inherit the deceased’s investments within an ISA wrapper—pensions generally offer greater flexibility. Pensions can be passed on to any dependant or individual nominated by the member (at the discretion of the trustees). If death occurs before age 75, beneficiaries using drawdown can make withdrawals tax-free. However, lump sum death benefits will only remain tax-free up to the deceased’s remaining lump sum death benefit allowance. For deaths occurring after age 75, income tax will apply to all payments, based on the beneficiary’s marginal rate.
One of the key death benefits that pensions hold over ISAs is that they are usually not included in the estate for IHT purposes. However, this advantage looks set to end in April 2027.
A bright future for the LISA?
The current Treasury Committee review of the LISA will hopefully lead to positive changes. Key suggestions include increasing the £450,000 property price limit to better reflect current real estate market conditions, particularly in high-cost regions. Another area under scrutiny is the withdrawal penalty structure—reducing it from 25% to 20% would eliminate its punitive nature while still preserving incentives for long-term saving. Additionally, raising the annual subscription limit beyond £4,000 would significantly enhance the LISA’s utility as a retirement planning tool, especially for individuals who opened accounts near the upper age limit and have fewer years to contribute before the age 50 cutoff.
For those currently eligible to open LISA accounts, maximizing annual subscriptions remains a prudent strategy due to the guaranteed 25% government bonus. This is particularly advantageous for basic rate taxpayers, who may find LISA savings more beneficial than equivalent pension contributions in certain scenarios. However, higher-rate taxpayers should carefully evaluate whether pension contributions offer greater tax advantages before prioritising LISA savings over pensions. Even if a LISA is not currently a priority, for client’s approaching age 40, opening a LISA with just a small subscription provides a gateway for future contributions.
All information is based on our understanding and interpretation of applicable law and regulation.
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