When it comes to managing your money, one of the most important questions is: where should you put your savings? Everyone wants their nest egg to grow as much as possible, and with so many investment options and savings accounts, the amount of choices can feel overwhelming. 

The Lifetime ISA (LISA) is a great option for any young adult (aged 18 to 39) planning to buy their first home or build up a retirement fund. But there are strict rules, pros and cons. In this blog, we’ll dive into the small print and find out whether a LISA is right for you.

Savings, interest, and ISAs

Before we get to the LISA, it’s worth taking a quick look at how savings accounts work. A savings account allows you to store your money separately to your current account. Any money you put in your savings account will earn interest, which is extra money earned as a percentage of what you put in. It’s essentially a reward for saving money.

The amount of interest you earn is primarily determined by interest rates, which are set and reviewed by the Bank of England roughly every six weeks. In a normal savings account, any interest you earn is tax free up to a certain amount, but once you earn more than that, you’ll have to pay income tax, and potentially capital gains tax. 

It makes sense to put your savings wherever they have the best chance of growing - that is, wherever they can earn the most interest, and wherever that interest won’t be taxed as heavily. 

This is where an ISA comes in handy. ISA stands for Individual Savings Account, and it’s a savings account where you don’t have to pay any tax on the interest you earn. 

Every UK resident can typically put up to £20,000 into an ISA each tax year (April 6th to April 5th). There are six types of ISA to choose from, and the difference between them mainly comes down to flexibility. Some let you access your money freely, without penalty, while others prevent you or charge you for accessing your money within a certain timeframe.

Which ISA is the best choice depends on how long you’d like to invest for, how strong the interest rate is, and whether you’d like to have easy access to your savings. 

What is a Lifetime ISA?

The Lifetime ISA was introduced in 2017, and is essentially a government-backed bonus scheme entitling you to up to £1000 of tax free cash per year. It can only be opened by people between the ages of 18 and 39, and there are strict rules about what any money invested in a LISA can be used for, and when. 

How do LISAs work?

You can invest up to £4000 per year in a LISA, and the government will pay you 25% of any money you invest. This money will also earn interest, like any other savings account. 

So, if I invest £4000 of my savings into a LISA - the full amount that can be invested in a year - the government will pay me another 25% of that money, which is £1000. So I’ll end up with £5000, plus any interest that money then gathers. Or, if I only have £2000, the bonus will be £500, and I’ll end up with £2,500 plus interest. Pretty sweet!

Each bonus is paid back monthly and there is no minimum contribution, so if you’ve only got a small amount saved right now, you’ll still be paid your 25% bonus at the end of each month. You can keep paying money into your LISA up to the age of 50, at which point you can no longer invest and you won’t receive any more annual bonuses. Your account will stay open though, and your savings will still earn interest. 

What can the Lifetime ISA be used for?

The LISA was designed to help young adults save for one of two major life goals: buying their first home or preparing for retirement. If neither of these goals applies to you, the LISA is not designed for you, and you could fall foul of the strict rules around withdrawing your money. 

You can only withdraw money from a LISA (without being penalised) if you’re:

• Buying your first home, provided you’re buying it at least a year after your first LISA payment

• Aged 60 or over

• Terminally ill, with less than 12 months to live

If you don’t fit these criteria or withdraw your LISA cash for any other reason, you’ll pay a withdrawal charge of 25%. This is particularly important for anyone withdrawing money less than a year after opening a LISA, because paying the penalty fee leaves you with less money than you started with in this instance.

Buying Your First Home

You can use your LISA savings to help you buy your first home, provided the property costs £450,000 or less and you’re buying with a mortgage (i.e. you’re not a cash buyer). The property has to be where to plan to live, not a buy to let, and you have to use a conveyancer or solicitor to act for you in the purchase (which is the usual way property sales are handled). 

If you’re buying with someone else, and the other person also has a LISA, you can both use your savings and government bonus, provided you’re both first-time buyers. This makes the LISA a great choice for couples looking to take the next step. 

Saving for Retirement

The other option for your LISA, if you’re not buying your first home, is to use it as a retirement fund. Remember, you can keep paying into the account until you’re 50, but you won’t be able to withdraw anything (without paying the penalty) until you’re 60.

So, as a 30 year old, if I decided to put £1000 in my LISA every year until I’m 50, I would get an extra £250 a year from the government for 20 years. According to this calculator, with interest, I’d reach 60 with a retirement pot of nearly £42,000!

Pros and cons of opening a Lifetime ISA

Pros

• Great for first time buyers
  The LISA is the best savings account to use to grow your savings for a mortgage if you’re certain your circumstances won’t change. If you want to buy a property but need to save for a few years, opening a LISA as soon as possible and topping it up every year is a great way to get the ball rolling. And if you’re looking to buy with a partner or friend, having two LISAs on the go will maximise your savings.

• Great for saving for retirement 

The same goes for anyone building their retirement pot. If you open your LISA at 18 and pay in every year until you’re 50, that’s 32 years of receiving the government bonus, plus interest, plus another 10 years (minimum!) for your savings to acquire interest before you can withdraw at 60. If retiring comfortably is important to you, this is a smart way to futureproof your finances.

• Great for anyone with a lot of savings

If you’ve already saved a good amount of money towards a mortgage or retirement fund, you can make the most of the LISA by paying in the full amount (£4000) for as many years as possible. Maxing out your LISA means you get the full government bonus (£1000) and your savings will earn as much interest as possible. Remember though, you’ll need to wait a year to use your LISA money to buy a house, so don’t fall into the trap of withdrawing within the first year. You’ll end up with less money than you started with!

• Great for savvy long term saving

As Martin Lewis recently advised, you can get the most out of the LISA by opening one as soon as you (or your children) turn 18 and paying as little as £1 into it. By doing this, the clock starts ticking on your first year, meaning you won’t have to wait to use your savings later down the line. You’ll also have as many opportunities to receive the government bonus as possible, year after year. 

Cons

• The £450,000 threshold for home buying

For many first-time buyers, £450,000 is a lot of money, and far too expensive for most starter homes. But a considerable minority of people will be looking for properties around this price, whether that’s because they’ve earned or saved a lot of money, or because they’re buying in an expensive area. The average property price in London is £567,000, which is way above the threshold, and cities like Cambridge and Oxford are similarly expensive. For people buying in these areas, the LISA might end up being more restrictive than it’s worth. If you think the property you want might break the threshold, it’s worth looking at other options for saving.

• Weakened by rising property prices

A related problem is that property prices have risen steadily since the LISA was introduced, while the £450,000 price cap has stayed the same. This means the purchasing power of the LISA has reduced over the years, and the number of properties available to buy with a LISA has dwindled. To guarantee savers can still get bang for their buck, campaigners like Martin Lewis have called on the government to raise the £450,000 threshold to reflect rising prices and inflation.

• The withdrawal penalty

If you’ll need to access your savings quickly - for example in an emergency - the LISA is not for you. It ties up your savings for at least a year, and you’ll be penalised for withdrawing money for the wrong reason. With the rising cost of living, many more people have been making unauthorised withdrawals, so be smart about the amount of money you invest. If easy access to your savings is what you need, then an easy access Cash ISA is a better option.

• LISA savings affect eligibility for benefits

In a situation recently described by the Treasury Select Committee as “nonsensical”, any savings held in a LISA will be means tested if you ever apply for universal credit or housing benefit, essentially penalising you for long term economic planning. This is another aspect of the LISA that campaigners have earmarked for reform.

So, the Lifetime ISA isn’t right for everyone, but if you’re a first-time buyer or looking to grow your retirement savings, it could be one of the smartest places to put your money. Just make sure to read the small print and weigh the pros and cons carefully before investing.