How a lifetime ISA works

A lifetime ISA is a tax-free, long-term savings account geared towards helping people save for a major life event. 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 save (and get a little help along the way), a lifetime ISA could be a good option, especially if you’re saving for your first home or towards your retirement.

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 towards a milestone event, such as 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% government contribution you can only transfer a maximum of £4000 per tax year into your ISA. 

What are the rules of the lifetime ISA?

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. 

Here are guidelines for opening and holding a lifetime ISA:

  • You must be between 18-39 years old to open a lifetime ISA
  • 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 (up to a maximum of £1,000 a year)
  • You can transfer up to a maximum of £4000 per tax year into your lifetime ISA
  • The 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

What are the pros and cons of a lifetime ISA?

When making any long-term financial decision, 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. 

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. 

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. 

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 one 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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