What is a Lifetime ISA?

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If you’re between the ages of 18 and 40, you have the option to set up a Lifetime ISA (LISA). But what actually is it and will you benefit? To help you decide if a Lifetime ISA is right for you, we’ve run through how they work and what they can be used for in this quick guide.

What is a Lifetime ISA?

A Lifetime ISA is a type of ISA that you can either use as a deposit for your first home or as an income in your retirement. If you open a Lifetime ISA, the government will give you a bonus each tax year worth 25% of the amount you put in, up to a certain limit.  

How does a Lifetime ISA work?

Each tax year, you can add a maximum of £4,000 to your Lifetime ISA. The government will then add a bonus 25% of the amount you put in. This means that you can earn a maximum of £1,000 a year in bonuses from the government. Bonuses are paid monthly.

Whatever you put into your Lifetime ISA will be included in your annual ISA allowance. Your annual ISA allowance for the year is currently £20,000. So, if you put £4,000 into your Lifetime ISA, you could put £16,000 into another ISA over that tax year. Your bonus is not included within your ISA allowance.

You need to have had a Lifetime ISA open a year before you can use it. So, even if you’ve not got much money to put into it right now, it can be worth opening one with just £1 to start the clock counting down. You can keep paying into your Lifetime ISA until you reach 50 years old.

Who is eligible for a Lifetime ISA?

To be eligible for a Lifetime ISA, you’ll need to be between the ages of 18 and 40 and a UK resident.

If that applies to you, then you can open a Lifetime ISA at any bank or building society that offers the product.

What can I use a Lifetime ISA for?

You can use a Lifetime ISA for either:

  • Buying your first home
  • An income in your retirement

If you’re already a homeowner, you’ll only be able to use your Lifetime ISA as an income in your retirement. If you’re not, then both these options are open to you.

This means that you can only access your money saved in your Lifetime ISA when:

  • You buy your first property
  • You are aged 60 or over
  • You are terminally ill and have less than 12 months to live

If you wish to take the money out for any other reason, you’ll have to pay a 25% withdrawal charge. This essentially means you’ll get your savings back but will lose any bonuses from the government.

Using a Lifetime ISA for a first-time buyer deposit

If you’re a first-time buyer, a Lifetime ISA can be an effective way to help you save for a house deposit. For instance, if you saved £4,000 a year for five years, you’d receive an extra £5,000 from the government. So, instead of having £20,000 in savings, you’d actually have £25,000 to play with.

However, there are a few restrictions on using a Lifetime ISA to buy your first home that you need to be aware of. These include:

  • You must not have owned a property before anywhere in the world
  • You can only use your Lifetime ISA on a home worth £450,000 or less
  • You must have a traditional repayment mortgage
  • You must live in the home you intend to buy

Advantages

  • It will top up your house deposit savings by 25%
  • You could save up for a home quicker
  • If you’re buying with a partner who is also a first-time buyer, you can both have Lifetime ISAs

Disadvantages

  • You can only use it on homes worth up to £450,000
  • You can’t use it for buy-to-let properties

Using a Lifetime ISA for a pension

If you’re looking to use your Lifetime ISA in your retirement, you’ll be able to make withdrawals without a penalty charge when you turn 60.

You can keep paying into it until you turn 50, so after that you have to leave your savings untouched for 10 years. If you have a stocks and shares Lifetime ISA, the amount may still grow over time (although it could also fall). Any investment gains remain tax-free.

Advantages

  • You could earn a 25% bonus on top of everything you save – that’s a maximum of £33,000 if you saved £4,000 a year between the ages of 18 and 50.
  • You don’t pay any tax on the withdrawals. With a pension, you can only take 25% of it as a tax-free lump sum. You then pay income tax on the rest at your marginal rate
  • The product is still active after you reach 60, so if it’s a stocks and shares ISA, it could still grow
  • You don’t have to take it out all at once, you can take out partial withdrawals

Disadvantages

  • You can only save £4,000 per year
  • You can only access your money and keep the bonus after you turn 60. For pensions, you can access your money from 55 years old (although this is set to increase)
  • If you’re employed, auto-enrolment means your employer will match some of your pension contributions. You wouldn’t get this with a Lifetime ISA
  • Higher rate taxpayers will pay more income tax than they would gain financially with the Lifetime ISA bonus. As pension contributions are deducted before income tax, you would keep more of your money with a conventional pension
  • Saving in a pension doesn’t affect your benefit entitlement, however Lifetime ISA income will
  • Lifetime ISA savings can be taken to pay creditors if you are declared bankrupt, however your pension is protected

While the Lifetime ISA can be a lucrative way to top up your savings, it does come with restrictions on how you can use it. So, as with any financial product, it’s essential you weigh up the pros and cons before you make your decision on what’s best for you.

If you’re looking to buy your first home, our team at Freedom Mortgages can help you find out your mortgage options. Get in touch with them today.

Want to know more about buying your first home? Our blog is full of handy resources to get you up to speed: