How a lifetime ISA works

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A lifetime ISA is a tax-free, long-term savings account geared towards helping people save for a first home or retirement. You can save up to £4,000 each tax year into your lifetime ISA, which the government will top up with a bonus of 25% paid monthly. For those who are looking to get onto the property ladder or put money aside for later life (and get a little help along the way), a lifetime ISA may be worthwhile. However, as always, it’s important to consider a range of savings accounts to find the best option for your needs.

The rundown
  • Financial milestones: A lifetime ISA is a tax-free savings account designed to help you buy your first home or save for retirement
  • Lifetime ISA bonus: The government tops-up your lifetime ISA savings by 25%, up to a maximum of £1,000 a year
  • Suitability: There are various lifetime ISA rules and restrictions to be aware of, meaning this type of account may not be suitable for everyone

What is a lifetime ISA?

A lifetime ISA, or LISA, is a tax-free savings account to help young people aged between 18 and 39 kickstart their financial future or save for retirement. The ISA is designed to help you save for a first home or a nest egg for your retirement. 

If you have a lifetime ISA, the government will grant you a 25% bonus each month, which can encourage you onto the property ladder or to build your savings for later life. There’s no limit on how much you can save over the course of your lifetime ISA, but to be eligible for the 25% lifetime ISA bonus you can only transfer a maximum of £4,000 per tax year into your ISA.  

You can hold cash or stocks and shares in your lifetime ISA, or have a combination of both.

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The lifetime ISA rules

There are certain restrictions around a lifetime ISA which you’ll need to check before deciding if this is the right kind of savings account for you. As when opening any kind of savings account, you should always look for the most competitive interest rates and the best terms and conditions to suit your needs. 

The lifetime ISA rules for opening and holding an account are as follows:

  • You must be between 18-39 years old to open a lifetime ISA
  • You must make your first payment before you turn 40 
  • You can continue to pay into your lifetime ISA until you are 50 years old
  • If you’re opening a lifetime ISA to buy a property, you cannot already be a homeowner
  • The government will pay 25% on your savings (the lifetime ISA bonus is capped at £1,000 a year)
  • You can transfer up to a maximum of £4,000 per tax year into your lifetime ISA
  • The lifetime ISA bonus should be paid into your account monthly
  • If you do not use the money for your first property, or you withdraw the money before you turn 60, you may have to pay a 25% penalty
  • The £4,000 annual limit of your lifetime ISA counts as part of your annual £20,000 ISA allowance

Using the lifetime ISA to buy your first home

If you’re planning to save for a deposit to buy your first home (or you think there’s a chance you might in the future), a lifetime ISA may be a good option. However, as we touched upon above, there are a few conditions you’ll need to meet.

To use your lifetime ISA savings and bonus to buy a home, you must have never owned a property in the UK or overseas before. This includes owning a property (or a share of one) that you inherited, even if you never lived there. Crucially, you should be buying a residential property that you intend to live in, so you can’t purchase a property with the intention of renting it out straight away. As the lifetime ISA is designed to help people buy their first home, you’ll also need to purchase the property with a residential mortgage – cash buyers or those with a buy-to-let mortgage aren’t eligible.

Price is another consideration. To use your lifetime ISA savings and bonus towards your property purchase, the property should cost £450,000 or less. Alternatively, you can use your lifetime ISA to buy land for a self-build property, providing the purchase meets all the other criteria. You can also use the money in conjunction with other government schemes such as shared ownership, Help to Buy loans and Right to Buy.

If you’re considering a lifetime ISA, bear in mind that your account will need to be open for at least 12 months before you can use the funds (and government bonus) to buy a property. So if you intend to purchase a property within a year, you’ll have to look at alternative savings options (more on this later). On the plus side, if you’re buying a property with another first-time buyer (e.g your spouse, partner etc), you can both open a lifetime ISA, effectively doubling the government bonus.

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Saving for retirement with a lifetime ISA

While a lifetime ISA can be a tax-efficient way of saving for retirement in some cases, there are some caveats. 

The rules state you must open a lifetime ISA before the age of 40, although you won’t be able to access the funds until your 60th birthday. This means you’ll need to be prepared to wait at least 20 years before you can access your cash, which may not be ideal if you plan to retire early. However, once you turn 60, you can withdraw your funds (including the government bonus) and spend the money as you wish.

It’s worth noting that you don’t need to take all of the cash out in one lump sum; you can leave some or all of the money invested if you prefer. Any withdrawals you do make will be tax-free, although bear in mind that your lifetime ISA savings can affect your entitlement to certain benefits.

Although a lifetime ISA has its advantages, for many people, paying into a pension may be more effective. If you’re employed, the auto-enrolment rules stipulate that your employer must also contribute into your pension; they don’t have to do this with a lifetime ISA. What’s more, as pension contributions are deducted from your pre-tax salary, you’ll benefit from national insurance relief as well as tax relief. For higher rate taxpayers, the advantages of a pension over a lifetime ISA are even greater as they’ll receive tax relief at 40% compared to 25% in a lifetime ISA.

Whether a lifetime ISA is right for you depends on your individual circumstances and your savings goals. If you’re unsure about the best option, speak to a financial adviser.

The pros and cons of a lifetime ISA

If you’re thinking of opening a lifetime ISA, it’s always a good idea to weigh up the pros and cons. A lifetime ISA has a lot of benefits, but it’s worth looking into how it works in detail to check if it’s right for you.

The pros 

One of the biggest advantages of the lifetime ISA is that you can earn tax-free money on your savings. For every £4 you place in your lifetime ISA, the government will top that amount up by an extra £1 until you hit the £4,000 tax year limit.

Another bonus with the lifetime ISA is that when you withdraw your savings, they will be tax free. In addition, any compound interest earned on top of your savings will be tax free too. You also get your government bonus paid on a monthly basis, which means you can benefit from any compound interest paid.

If you’re saving for retirement, you can continue benefiting from the monthly interest right up until you reach the age of 50. This means that even if you open a lifetime ISA later in life, you can still benefit from the 25% bonus and any interest, which will give your savings a boost when it’s time to cash out. Again, you won’t pay any tax when it’s time to withdraw your funds. 

The cons

The lifetime ISA limits you to transferring £4,000 maximum per tax year, and this amount counts towards your annual overall ISA allowance of £20,000. This leaves you with £16,000 leftover to divide between other ISA accounts and stocks and shares. 

There are also limitations on how you use the funds from your lifetime ISA. 

A penalty of 25% of your funds may be applied if:

  • you don’t use the funds to buy your first home, or
  • you withdraw the money before the age of 60.

If you’re saving for retirement, your lifetime ISA will earn the government top-up until the age of 50, but you won’t be able to access the funds until you are 60. Plus, unlike a pension, any money saved in a lifetime ISA will be treated as a normal asset when it comes to bankruptcy cases.

Is a lifetime ISA worth it?

A lifetime ISA can be worthwhile if you’re saving towards retirement or for your first property. The main advantage is the government will top up your savings account by 25%, up to a maximum of £1,000 per tax year.

If you’d prefer a more flexible savings account that doesn’t restrict where your savings can be spent, you may want to consider a fixed rate bond or a different type of ISA, for example a cash ISA or flexible ISA. If you’re saving for your first property or are comfortable with your money being locked away for a long period, the lifetime ISA can be a good option for saving.

How to find the best lifetime ISA providers

As when opening any type of savings account, it’s important to compare a range of lifetime ISA providers as interest rates can vary significantly. It’s also essential to read the small print; some lifetime ISAs require a minimum opening deposit while others don’t accept transfers from other ISAs. And if you’re thinking of opening a stocks and shares lifetime ISA, remember to check the management fees and charges. High fees can erode the value of your investment over time.

Once you’ve identified a lifetime ISA provider that works for you, you’ll need to apply directly with them to open an account (more on this below). After you’ve opened an account, it’s a good idea to keep an eye on the rate to ensure it remains competitive. Don’t be afraid to transfer your lifetime ISA to another provider if you find a better deal; loyalty doesn’t always pay.

Opening a lifetime ISA

To open a lifetime ISA, you’ll need to provide some essential details such as your name, date of birth, address and national insurance number. Your chosen lifetime ISA provider will then use this information to check you’re a UK citizen and that you meet the other eligibility criteria.

You can hold multiple ISAs but you can open and pay into one lifetime ISA every tax year. It’s also important to remember that the £4,000 lifetime ISA limit counts towards your overall annual £20,000 ISA allowance.

Although we don’t currently offer lifetime ISAs at Raisin UK, you can compare a range of other types of savings accounts from our partner banks through our marketplace. Simply register for a Raisin UK Account (it’s free!) and then log in, apply for your chosen savings account and transfer your deposit.

What are the alternatives to a lifetime ISA?

You might want to consider alternatives to the lifetime ISA, to find the best option for your needs. 

If you aren’t eligible to use your lifetime ISA funds because you want to buy a property within a year of opening the account, it may be worth considering a notice account. This type of account allows you to take advantage of competitive variable interest rates and still have the flexibility to withdraw your money after a set notice period (typically between 30 to 180 days).

Alternatively, a fixed rate bond could be a good option if you’re seeking the most competitive interest rates in a savings account where your money is locked away for a certain period of time. With a fixed rate bond, you’ll see financial growth on your savings over a certain amount of time (anything between six months and five years), while knowing that you can access your money once the agreed time period has ended. Other options include opening a stocks and shares ISA or setting up a personal pension plan.

You can easily compare alternative saving options at Raisin UK, to find the best savings account for you.

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