All that glitters: beware the Lifetime Isa trap

Britain’s newest Isa is three years old – but is it fit for purpose? The jury is still out,

It was launched to much fanfare as a way to help people buy their first home or save for retirement, but the Lifetime Isa has ended up heaping further confusion on savers.

The premise should be simple. For every £1 a customer deposits in a Lifetime Isa, the Government tops up their contribution with a 25p bonus. The maximum that can be saved each year is £4,000, meaning the amount users can save each year towards a property or for their later years is £5,000.

However, savers have been left baffled over whether the Government bonus outweighs the benefits of saving into a company pension. And first-time buyers in expensive areas have been unable to purchase homes because of the scheme’s restrictions.

Those who later discover the Lifetime Isa is not suitable for their needs face punishing exit penalties for withdrawing their cash. If a saver decides to use their money for a different purpose than buying a first home or saving for retirement, they are hit with an effective 6.25pc charge. Experts have called on this penalty to be removed as it is a barrier to saving.

Andrew Hagger of Moneycomms, a financial industry analyst, said many people were caught out by the high penalties. “On the face of it, the potential bonuses look attractive for those who use the Lifetime Isa for pension or property purchase,” he said. “However, the penalties for withdrawal are harsh for those who, for some reason, decide not to use the Lifetime Isa for its intended purpose – not intentionally but perhaps due to a change in their circumstances.”

Hundreds of thousands of accounts have been opened since the Lifetime Isa was launched in 2017. Customers using Skipton Building Society, the biggest provider, have already saved a collective £1bn, which the Government has topped up by £250m.

Both cash and investment options are available. But while major stockbrokers including AJ Bell, Hargreaves Lansdown and The Share Centre have accounts for consumers looking to invest, no high street banks offer the cash version of the Lifetime Isa. Only a handful of accounts are available, all from online providers and building societies. Currently the toppaying Lifetime Isa is offered by mobile app Moneybox and earns customers 1.4pc in interest per year.

Anyone aged between 18 and 39 can

‘The penalties are harsh for those who, for some reason, decide not to use the Isa for its intended purposes’ ‘The golden rule is exhaust your work pension first, as it’s free money you won’t get from a Lifetime Isa’

open a Lifetime Isa. Skipton Building Society said it had helped 15,255 people on to the ladder, with thousands more ready to purchase.

However, even those who wish to use the savings account for one of its two intended purposes are being hampered by further limits on the scheme.

The Lifetime Isa must be used to purchase a home that is worth less than £450,000. While the average property purchase price with a Lifetime Isa is £248,000, according to Skipton, many buyers in London and other expensive areas have been left unable to purchase even modest two-bedroom flats.

These people, and others who have paid into a Lifetime Isa and later wished to withdraw the money, face a 25pc deduction from their balance. In effect this means they will receive 6.25pc less than they put in.

Laura Suter of AJ Bell called on this tough penalty to be removed.

“Reducing this charge to 20pc of the amount withdrawn – in effect just returning the Government bonus – would be fairer and make understanding the Lifetime Isa’s benefits more straightforward,” she said.

Ms Suter said the firm’s research had found that 20pc of people were unaware of the harsh exit penalty when putting their cash into the scheme.

By offering an investment Lifetime Isa for first-time buyers, the Government is also effectively promoting the idea that investing towards a short-term goal is wise. In reality, one fall in share prices – as seen in recent weeks – shortly before the buyer completes their purchase could leave them with a black hole in their finances worth thousands of pounds. Would-be buyers should proceed with caution if they choose to invest.

Saving for retirement is another way to use the Lifetime Isa, but the scheme has added a new layer of complexity to a pension system that is already convoluted. Savers can enjoy the yearly Government bonus until they are 50, but in most instances those using the Lifetime Isa will be sacrificing other more valuable tax breaks to do so. In some cases, people may have put their money into a Lifetime Isa when a traditional pension would be much more suitable and generate more lucrative bonuses.

Analysis by AJ Bell for Telegraph Money looked at the pension options for an individual making an £800 annual contribution, which would mean £1,000 in the Lifetime Isa pot.

Employed basic-rate taxpayers investing the same amount into a pension would add £1,700 to their savings, thanks to tax relief and employer contributions. Those who are higher-rate taxpayers would receive £1,913, assuming that they reinvest their tax relief into their pension – almost twice as much as a Lifetime Isa.

However, for some savers there are scenarios where a Lifetime Isa would provide a welcome boost to their retirement fund. For example, self-employed basic-rate taxpayers would only add £850 to their pension, meaning a Lifetime Isa would be more suitable. A higher-rate taxpayer who is self-employed would receive £1,063 into their pension, based on this £800 contribution.

Ms Suter warned that Lifetime Isa holders must wait until they are 60 before they can access their savings, compared with 55 for a pension. However, they will benefit from being able to withdraw all their cash without paying tax, whereas only 25pc of pension income is tax-free.

“You need to be clear whether a pension or Lifetime Isa is right for you before you sign up,” she said.

“The golden rule is if you’re going to get some form of contribution from your employer into your pension you should exhaust that first, as it’s effectively free money that you wouldn’t get with a Lifetime Isa.

“As self-employed people won’t get this employer contribution, they may benefit more from using the Lifetime Isa, as it has a combination of added flexibility and the 25pc savings bonus.”