Get paid £1,000 for saving each year with a Lifetime Isa

More than half a million savers are scooping up to £1,000 a year in free money by opening a Lifetime Isa (Lisa) to buy their first home or save for retirement.

Lisas were launched in April 2017, and savers deposited £1.25 billion in the tax year 2019/20. But the lucrative scheme comes with strict rules which, if broken, result in a stiff penalty that will leave a dent in your nest egg.

Here, we explain how Lifetime Isas work, their perks and pitfalls — and how to choose a good deal.

Long-term savings: Lisas were launched in April 2017, and savers deposited £1.25bn in the tax year 2019/20. But the lucrative scheme comes with strict rules

Join the club

HMRC’s latest provisional figures showed there were 545,000 subscriptions to Lifetime Isas in 2019/20.

To open one, you must be aged 18 or over and under 40. You can deposit up to £4,000 each tax year and earn a 25 per cent bonus on contributions up to £1,000 a year. The £4,000 counts towards your annual £20,000 Isa allowance.

As with an ordinary Isa, you can choose a cash or stocks and shares option. You earn tax-free interest on your savings, plus a government bonus, and pay no tax on dividends or capital gains if your money is invested.

To avoid forfeiting the ‘free money’ and losing some of your own savings, too, you must adhere to the government’s restrictions on how you spend your savings. 

You can use them to buy your first home, which cannot cost more than £450,000, or you must leave them untouched until you turn 60.

There is an exception for account holders who are seriously ill. Taking cash out for any other reason will trigger a 25 per cent withdrawal charge. 

Holly Mackay, chief executive of personal investing website Boring Money, says: ‘Lifetime Isas are great if you are dead-set certain you want to buy a home. But they’re not for the undecided.

‘The penalties if you change your mind or can’t leave it set aside until you are 60 are hefty. If that’s your chosen path, though, there is nowhere else you will make the same guaranteed tax-free return.’ 

Your bonus is added automatically to your account each month, based on the value of your total deposits in the previous month.

You cannot buy a property using your Lisa savings until at least 12 months after making your first deposit, so open your account as early as possible.

Being an early bird has other benefits too, says Cecilia Mourain, managing director of homebuying at personal finance app Moneybox. 

She says: ‘You can open an account with just £1 and start benefiting from the government bonus, so even if you aren’t able to use the full £4,000 tax-free allowance each year, every little helps. 

The tax-free allowance and bonus do not roll over from one year to the next. If you don’t use it, you lose it.’

Couples buying their first home together can have a Lisa each and combine their individual bonuses to boost their homebuying power.

First-time buyers: You cannot buy a property using your Lisa savings until at least 12 months after making your first deposit, so open your account as early as possible

First-time buyers: You cannot buy a property using your Lisa savings until at least 12 months after making your first deposit, so open your account as early as possible

Long-term gains

If you’re already a homeowner, you can pay into your account and enjoy bonuses until your 50th birthday, but you cannot withdraw your savings until you turn 60.

Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, says: ‘If you’re employed, you should take full advantage of all the [pension] contributions your company is willing to pay. After that, consider paying into a Lifetime Isa.

‘Self-employed people may find them particularly beneficial as they don’t benefit from auto-enrolment.’

If you opened a cash Lifetime Isa paying 0.5 per cent interest aged 18, contributing the maximum amount until your 50th birthday, you would have £188,998 by your 60th.

Using a stocks and shares Lisa paying a 5 per cent annual return would boost your funds to £597,868, according to Hargreaves Lansdown.

Once you have used your Lifetime Isa savings to get on the property ladder, you can start saving back into your account for your retirement.

Penalty pain

The biggest drawback of the Lisa is the 25 per cent withdrawal penalty. At first glance, it appears the government is just taking back its 25 per cent bonus. 

Yet you will lose some of your savings, too. If you put £4,000 into your Lifetime Isa, you would receive the 25 per cent government top-up, taking your balance to £5,000. 

If you later withdraw £5,000, you will be charged a 25 per cent withdrawal penalty of £1,250, taking away £250 of your savings.

Between March 6, 2020, to April 5, 2021, the government reduced the withdrawal penalty to 20 per cent. Ms Morrissey wants to see the penalty back at 20 per cent permanently.

She says: ‘Although savers open a Lifetime Isa with the best of intentions to invest and contribute for the future, if something unexpected happens and you need that money, you should only lose the bonus, not your own savings, too.’

In the last tax year, the Government banked £34 million in charges.

Another pitfall for first-time buyers is the maximum purchase price cap of £450,000.

According to the latest Office for National Statistics quarterly figures, the average price paid by a first-time buyer in London was £449,000, compared with £242,000 for the rest of the UK, putting dwellers in the capital almost at the limit.

A first-time buyer who breaches the limit when buying their property will also trigger the withdrawal penalty.

I’m buying a home thanks to lockdown

Lucia Harrison opened a Lifetime Isa with £1 in September 2020 to get started

Lucia Harrison opened a Lifetime Isa with £1 in September 2020 to get started

First-time buyer Lucia Harrison plans to buy a house this summer. 

Knowing her Lifetime Isa must be up and running for 12 months before any purchase, she opened it with £1 in September 2020 to get started.

Since then, management accountant Lucia, 26, has put in £8,000 of her money and received £2,000 in bonuses. She plans to save £4,000 more before summer to gain another £1,000 top-up.

Lucia, from Bristol, says before the pandemic she spent lots of money on herself and never considered the future. But with shops shut, she realised how much she could save for a home.

Lucia puts £500 a month into a cash Lifetime Isa with app Moneybox, where she also has a stocks and shares Isa. 

She also invests through apps Plum and Freetrade. ‘I’ll be buying my house solo, but I’ll have someone living with me to help pay the mortgage,’ she says. ‘Then I can continue saving into my Lifetime Isa and my investments.’

Investing best?

Ms Mourain says: ‘If you are investing over the long term, for five or more years, a stocks and shares Lifetime Isa can offer higher returns than putting your money into a savings account.

‘But it’s important to remember that the value of your investments can go up and down, and you may get back less than you invest.’

If you saved the maximum amount in a cash Lifetime Isa paying 0.5 per cent interest between the ages of 18 and 32 — the average age of a first-time buyer — you would have a £78,071 deposit to withdraw.

Savers who choose a stocks and shares account with a 5 per cent return would have a pot worth £109,341.

Those with less than five years to build up their house deposit are advised to use a cash Lifetime Isa to protect their nest egg from stock market volatility.

Although your capital is not at risk in a savings account, savings rates are much lower than inflation. 

Over time, inflationary pressures will erode the value of cash savings giving you less spending power in the future.

Shopping around

The top-paying interest rate on a cash Lisa is 0.85 per cent offered by Moneybox, according to Savings Champion. 

You can only operate the account through an app on your mobile phone and the opening investment is £1.

If a stocks and shares Isa is for you, you’ll need to decide if you want to use a DIY investing platform, where you choose your funds and shares or pick a ready-made portfolio suited to your risk appetite instead.

Help to buy Isas

Help to Buy Isas closed to new applications on November 30, 2019, but you can pay into yours until November 2029. You have an extra 12 months after that to claim your government bonus.

The maximum you can save is £12,000, depositing no more than £200 a month. Each monthly deposit is topped up by 25 per cent, giving you a maximum bonus of £3,000.

You can hold a Help to Buy Isa and Lifetime Isa at the same time, but you will not be able to use your Lifetime Isa towards buying a house. You can transfer your savings into your Lifetime Isa.

The transfer counts towards your £4,000 Lifetime Isa allowance.

Retirement on track for £12,000 boost 

Victoria Nicholl opened a Lifetime Isa to boost her retirement savings just in time.

The enterprise development director, 41, heard about its generous benefits but had just a year left to open an account.

‘I got in just before the cut-off age of 40,’ says Victoria, who lives in London. ‘Now I’ll be able to get a total of £12,000 in bonuses from the government over time.’

Since opening the stocks and shares Isa with Nutmeg in 2018, she has £17,559 after paying in nearly £15,000. The fund’s value fell recently from about £20,000 last year.

Victoria saves monthly into the account, using up her £4,000 allowance. She makes regular payments rather than a lump sum to benefit from stock market falls to buy units in her funds more cheaply.

Victoria has a ready-made portfolio rather than picking funds. She says: ‘Five years ago, I realised that relying on my state and workplace pensions might not give me the lifestyle I want in retirement.’