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Should I Get a Lifetime ISA (LISA)?

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With my house purchase well and truly complete, my next financial goal is to start investing for the future, so that I can watch my net worth increasing each month.

But what tool to use to achieve this?

In this article we’ll talk about Lifetime ISAs – both the pros and the cons – and I’ll tell you a little more about my final decision on opening a LISA.

[As a disclaimer these are just my personal opinions and discoveries – please take professional advice before doing any kind of investing yourself].

The Basics

A Lifetime ISA, sometimes simply known as a LISA (pronounced lice-a), is a tax advantaged way to save and/or invest for the future. By “tax advantaged” I mean that you pay no tax on your ISA earnings. 

Lifetime ISAs are designed with two specific purposes in mind:

  • Buying your first home
  • Saving for retirement

For first-time buyers they can be an effective way to save up a generous deposit before purchase – though I would strongly advise you to compare LISAs with Help to Buy ISAs if this is your goal.

Of course, for me, it is the second option that really appeals. It’s a way to gently pop money away each month so it can grow on autopilot for the next few decades. Then, in later life, I can access what I hope to be quite a juicy lump sum.

I have no specific goals in mind for that money, but that doesn’t matter.

What matters is having a nest-egg slowly growing for the future.

The Benefits of Taking Out a Lifetime ISA

There are a number of reasons why the idea of a Lifetime ISA appealed to me. Here are some of the most important discoveries I made:

Government Top-Up

Possibly the biggest benefit of a LISA in my opinion is that the government tops up your investment by 25%.

So, if you pay in the maximum amount of £4,000 a year, the government will top this up by £1,000 giving you a total of £5,000.

And this excludes any interest you make on your investment. 

For me, this means that funds can grow far more quickly. The British government are basically incentivizing you to save for the future, and giving you free money as a reward for doing so. And who doesn’t like free money?

Tax Free

The second benefit of LISAs is that like other ISAs your earnings are tax-free. That means you get to keep every penny you make.

This is in stark contrast to some other ways to save – such as a classic high street savings account – where you may be liable to pay tax on any interest earned. This, again, allows your money to accumulate faster. 

“Forced” Saving

As we’ll see shortly, you can only pay into a LISA for a finite period of time, and you can only pay in so much in each financial year. To make the most of a LISA, therefore, you’ll want to get as close to the maximum contribution limits as you can. 

Additionally, withdrawing money from a LISA, while possible, is fraught with difficulties (more on this later).

In essence I therefore see a Lifetime ISA as a form of “forced saving”, by which I mean this money is in essence “ring-fenced”. It’s a one-way street. Once money goes it I don’t expect to touch it for anything other than retirement. 

While some people will see this as a negative, personally I like the way that it encourages me to save as much as possible each month and to avoid touching it.

This is in contrast to a bank account, where you might be tempted to dip into your funds to pay for a holiday or a new car.

Better Potential Returns Than Savings Accounts

With interest rates so low, the savings accounts offered by most high street banks offer pretty pathetic returns.

A LISA not only offers the government top-up – which is tempting enough in itself – but potentially higher returns on your savings too. This could potentially create a larger nest-egg for either buying your first home or retiring in comfort.

Cash or Stocks & Shares Options Available

Lastly here you can choose how your money is invested. For risk-averse individuals, or those who want to access their money in the short term (such as when buying a house) a cash LISA offers very little risk. 

For those who are a little less risk-averse you can alternatively have your money invested in the stock market. Here the returns can be far more variable.

You’ve seen all the fine-print – investments in the stock market can go down as well as up. All the same, in most models returns from the stock market beat traditional savings accounts over the long-term.

The nice thing is that no matter what your risk tolerance there is a solution for you. 

The Downside to Lifetime ISAs

Lifetime ISAs may sound a wonderful idea, but it is important to understand the surprisingly long list of downsides they offer. 

Age Limitations

Lifetime ISAs come with significant limitations when it comes to your age. Firstly, you can only open a LISA if you are under 40 years of age. Personally I managed to sneak in below that threshold, but I know a number of friends in their 40’s who are gutted to have missed the Lifetime ISA boat. 

Secondly, you can only continue paying into a LISA until the age of 50.

For younger readers that may seem like a lifetime away. For those readers in their 30’s it’ll likely be here before you know it.

What this means, though, is that from the age of 50 you’ll have to find somewhere else to keep any new savings. 

Thirdly, there are limitations on when you can withdraw your money. The government guidelines state that you can either access your funds at the age of 60 – or if you become terminally ill before that time.

While you can in theory withdraw your money before that age you’ll pay an uncomfortable withdrawal penalty so that’s not something you want to do if it can be avoided. 

You’ll therefore only want to be investing money into a LISA that you’re confident you won’t need for decades to come. I know that early in my career there simply wasn’t enough disposable income to consider such a thing. 

Saving Limitations

Due to the generous government bonus on LISA contributions there is a cap on how much you can pay in each year. This is currently set at £4,000 per financial year.

If you want to save more money into an ISA then you’ll want another more traditional ISA into which you can pay the “balance”. 

For some people saving £4,000 a year is a big ask (roughly £333 per month) while for others this will be peanuts. All the same, if you have a high savings rate there’s nothing to stop you using a Lifetime ISA as part of your overall financial plan. 

Investments Can Go Down as Well as Up

If you opt to invest your money into the stock market then you need to be aware that you could get back less than you pay in.

Cash LISAs are available, but the returns can be more modest.

I, like many personal finance bloggers, am banking on the way that the stock market almost always grows over a long enough period of time. And as I won’t be accessing these funds until the age of 60 that’s lots of time for short-term corrections to have little effect on the end result.

Alternatives to Lifetime ISAs

While we’ve talked extensively about Lifetime ISAs so far it does make sense for us to consider the alternatives. After all, what if an alternative vehicle actually makes more sense for you?

Lifetime ISAs Vs Savings Accounts

My grandmother opened a savings account in my name when I was a school child and paid in a small initial investment. I’ve therefore been using a savings account for decades at this point, and I maintain the same account to this day.

So why consider a LISA in addition?

Interest Rates

Talking about interest rates is never easy, as by definition they change routinely. However at the time of my analysis the interest I was earning in my savings account was nothing short of pathetic.

While Lifetime ISA returns will of course vary – especially if you invest in the stock market – I was personally confident that over the long term I’d earn more with a LISA than by putting everything into my savings account. 

Government Bonus

Possibly the biggest incentive to open a Lifetime ISA is the government bonus – worth up to £1,000 per year to you. In fact, it could be worth quite a bit more…

Let’s assume you received that £1,000 bonus at the age of 30, that your LISA was invested in the stock market, and it therefore grew at an average of 5% per year.

Thanks to the magic of compound interest, if these figures hold true, that government bonus could be worth £4,321 by the age of 60.

Lets not forget that’s just one single year of contributions. Do the same thing year after year and my personal opinion is your nest-egg can grow impressively in the future.

To state the obvious a traditional savings account simply doesn’t offer this bonus, which could be worth a sizeable amount in the future, for really doing nothing more than you would have with your savings account. 

Taxable Earnings

I’m not a tax expert so I would advise you to seek guidance from a qualified accountant rather than just trusting what I say. However, my research suggests that earnings held in any kind of ISA – including a LISA – are tax-free. 

In contrast, from my understanding, interest earned in a standard bank account is subject to taxation. 

Therefore whether you opt for a Lifetime ISA or some other ISA it seems like a perfectly legal and legitimate way to reduce your tax bill and therefore retain more of your money for the future.

Access Levels

One of the biggest differences between Lifetime ISAs and traditional savings accounts is the level of access that you have. I can dip into my savings account whenever I like. In the blink of an eye I can transfer funds into my main current account so it offers considerable flexibility.

With a Lifetime ISA there are only a limited number of situations in which you can withdraw money without paying a penalty. The penalty is hefty too – so you’ll want to try and avoid this.

Therefore I would suggest that once money enters your LISA you consider it “gone”. Don’t expect to access it unless you’re buying your first home or you reach the age of 60.

For some people this lack of flexibility could be a real issue. What if you boiler suddenly needs replacing but all your savings are in a LISA? This could prove to be a sticky situation. With money in a savings account this scenario really would cause no issue.

On the other hand, that element of “ring fencing” your savings might be a positive for many people, as it removes the temptation to spend it frivorously. 

Personally I don’t think there’s a right or a wrong answer, and whether a Lifetime ISA or a savings account is better will depend on your personal circumstances and future plans.

What I would say is that if you opt for a Lifetime ISA then I think it still makes sense to maintain a savings account.

The savings account can be used to cover any short term emergencies, leaving the LISA account untouched. 

Lifetime ISAs Vs Pensions (SIPPs)

Over the years successive governments have offered tax incentives for saving into a pension. As things stand right now both pensions and LISAs offer tax benefits, so deciding between the two can be challenging. Here are the key differences I uncovered in my own research…

Pre-Tax Vs Post-Tax

While both pensions and Lifetime ISAs offer a legal way to save on tax they differ on where these incentives are applied. 

In the LISA situation you get paid from work. Your employer removes taxes – income tax and National Insurance – and gives you the remainder. This can then be invested into a Lifetime ISA, where any interest you earn is shielded from further taxes. 

In the pension situation your contributions are made before taxation. Let’s illustrate this with a simple example. You earn £100 from work that you want to invest. In the LISA situation your employer taxes you 22%, meaning that you have £78 left to invest that month. 

In the pension situation however the whole £100 goes into your pension – without tax being taken off. If you’re investing post-tax income into a pension your pension provider will even recover the tax you’ve paid and add that to your balance. 

The downside is that you’re then taxed when your pension pays out to you.

So both are tax-advantaged, except in one you’re taxed at the beginning and the other at the end. 

Employer Contributions

While Lifetime ISAs offer a government incentive, pensions can offer employer contributions. This typically works that you pay in X% of your monthly salary and your employer pays in a similar amount. Some employers – particularly larger organisations – can be surprisingly generous with their matching. 

It’s therefore worth running the numbers to see where your money would receive the biggest “boost” – either in a LISA or in your work pension scheme. 

Age of Access

A crucial difference between pensions and Lifetime ISAs is when you can access your money without penalty.

As stated earlier, you can access your Lifetime ISA at the age of 60. As things stand at the moment we can access our private pensions at the age of 55 though this will likely rise in the coming years. 

Broadly speaking you can access a private pension 10 years before the state pension, so as the state pension age continues to rise so too will the age at which you can access your private pension. 

This does mean that a pension might be beneficial for those of us who would like to retire early. 

My personal viewpoint on the LISA vs pension situation is that I want both. Neither is necessarily better.

My funds can be invested in a similar way in both vehicles. Both offer some kind of tax incentive, and a bonus – either from the government or my employer – to save money.

I like the idea of running both concurrently. My view is that it will be great to draw my private pension in my mid-50s (if I want to – otherwise I’ll leave it accruing interest).

The LISA will potentially pay out a few years later as a nice tax-free lump sum. 

Whether I’m sensible and use that to invest further and fund my senior years, or I use it to pay off my mortgage or buy a holiday home in the sun is still to see. Whatever the case that little nest-egg building up will be a very pleasant bonus as I age. 

Lifetime ISAs Vs Traditional ISAs

As the name suggests, a Lifetime ISA is a type of ISA. So why would anyone consider a LISA as opposed to a more traditional ISA?

Government Incentive

This one is simple: Lifetime ISAs offer a government incentive of up to £1,000 per year. Traditional ISAs do not. So for me it’s pretty clear that the LISA wins on this front.

Range of Providers

Despite the appeal of Lifetime ISAs for investors, there are a surprisingly small number of actual providers.

Many high street banks still don’t offer them.

This not only limits the range of institutions available to you, but may also require some research to find one that suits you.

In contrast, standard ISAs are far more readily available. Your own bank probably offers multiple options right now. This makes it simple to open an ISA as your bank already has all your personal details.

Personally I don’t think the range of providers is enough to turn me off LISAs but it is an odd hiccup in the process of opening one.

Access Levels

Accessing your savings varies significantly between ISA vehicles. As stated earlier, you can only access your Lifetime ISA without penalty in a limited number of circumstances: buying your first home, reaching the age of 60 or when terminally ill.

This means your money needs to stay where it is for a long time to come.

In contrast, you can potentially pay into and withdraw from a standard ISA at will. As a note of warning, you should make yourself aware of how this affects your tax-free contribution limits before treating your ISA like an instant-access savings account. 

Maximum Contributions

The maximum that you pay into a LISA is currently £4,000 a year, with the government topping that up to £5,000. 

Traditional ISAs however have a far higher annual limit. This changes regularly, so I’d advise you to check the exact figure with your provider. For the sake of argument, however, at the time of writing this figure was £20,000 per year.

Rather like our discussion about pensions vs LISAs there isn’t necessarily a clear winner here. Sure, the government incentive is appealing, but with low annual limits and little access to your money it is hardly the most flexible option. 

My personal opinion – and this really is just my opinion – is that it makes sense to pay into a Lifetime ISA first to get those juicy bonuses – so long as you’re confident you won’t need those funds in the near future.

Then, if you’ve still got more money to invest, you consider popping it into a standard ISA or a pension. 

Did I Open a Lifetime ISA?

So after all this talk, the question is whether I actually ended up opening a Lifetime ISA. The simple answer to this question is “yes”. However I don’t want to just leave things there – I want to spend a few minutes fleshing out my answer and telling you about what I chose and why. 

To be clear, whether you follow my lead or not is up to you. I would advise you to do your own research and seek the guidance of a suitably qualified advisor. I most certainly am not advising you to do exactly as I have done.

At the same time, I know that saving and investing for the future can be an intimidating proposition. Furthermore, very few people really talk specifically about what they’re doing.

So hopefully the following will be useful for some readers considering starting a Lifetime ISA.

Which LISA Did I Choose?

Having weighed up all the various options I opted for a Stocks and Shares Lifetime ISA with Hargreaves Lansdown.

My personal feelings are that short-term dips in the stock market are unlikely to affect me too much as it will be decades till I can access those funds.

My financial models suggest that with modest growth the closing balance when I hit sixty should be a comfortable six figure sum, which will make all the difference to my retirement. 

What Are the Results So Far?

At the time of writing I’m less than six months into having a Lifetime ISA. I have set up a direct debit to transfer funds into the ISA each month like clockwork. So far things have worked very smoothly. 

I know as a personal finance blogger that I really should just keep contributing and leave time and the magic of compound interest to do their thing, but I can’t help peeking at the balance every now and then.

So far, the growth is quite impressive, and seeing those extra bonuses landing is very nice too.

I now find it quite addictive to watch the balance increasing week after week, month after month. Just imagine what it’ll look like in 5 or 10 years time.

So – am I happy with my decision? So far the answer is “yes” – very much.

How Does a LISA Fit Into My Retirement Plans?

I don’t like the idea of putting all my financial eggs in one basket – just in case.

Rules change.

Taxation varies.

The retirement age is almost certainly going to alter.

So at present my retirement planning focuses on agility and being able to handle a range of situations.

This is in contrast to optimising everything for one specific event, only to find things turn out differently.

Personally I see my Lifetime ISA as a lump sum bonus to be enjoyed in the future. 

Here’s the potential timeline at present:

Firstly, of course, there’s the state pension which will be available to me at the age of 67 as I write this. That said, many people expect this to rise in the future. I have many years of contributions so I’m confident about receiving the maximum.

Ten years before this my private pension will start paying out, bridging the gap till my state pension arrives.

In the mid-point between private pension and state pension my LISA will pay out a tax free lump sum.

I plan to use this as I see fit.

I may re-invest it.

I may use it for living expenses before the state pension kicks in.

I may just do something fun with it.

Who knows? The point is it’s nice to know that lump is slowly growing ready for my golden years.

Lastly an ISA is there to bridge the gap between retiring and receiving my private pension. My age of retirement therefore depends primarily on my ISA balance, assuming I’m effectively funding all those various vehicles for maximum impact.

In closing, while I am a fan of Lifetime ISAs, in my opinion they should only serve as one part of your retirement planning.

Richard

Sun-worshipper and obsessive frugality blogger. For loads more money-saving advice come and join us on Facebook.

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