Lifetime ISA: how it works

Maike Currie
Maike Currie
Fidelity Personal Investing21 March 2016

The baby boomer generation, those born between the end of World War II and the early 1960s, are often referred to as ‘the richest, most powerful generation that ever lived…” In stark contrast, the younger generation – those so-called millennials, born after 1980, are routinely dubbed the ‘poorest generation in 25 years’.

By definition young people tend to be less well off than their parents – they haven’t been working for many years and so haven’t had the opportunity to save as much; but face the cost of large investments like education and new home ownership.

But beyond the fact that most people’s income and wealth tend to follow a natural pattern during their life, there’s no denying the growing generational divide that exists between the young and old.

Today’s youth face mounting student debt, the prospect of caring for an aging generation and are finding it increasingly difficult to get a foot on the property ladder.

The bulk of today’s tech-savvy millennials started their careers just as the global financial crisis kicked-off and many are still trying to catch-up after a period of poor job prospects and very little wage growth.

For this hashtagging, selfie-ing, status updating generation getting a foot on the property ladder is a huge challenge and while this generation is better educated than any other generation before them there is a price to pay in the form of mounting student debt.

Figures from the Office for National Statistics confirm that a record number of young adults are living with their parents today – up by a quarter since 1996, as home ownership among the young continues to decline. The percentage of young adult householders owning their home decreased from 55% in 1996 to 30% in 2015 for 25 to 29 year olds and from 68% to 46% for 30 to 34 year olds.

Getting a foot on the property ladder is one of the most pressing issues for the young, while saving into a pension is relatively low down on their priority list. For most millennials saving for both a property and a pension, is simply out of the question.

So step up Chancellor George Osborne. In his latest Budget, which had a strong theme of generational fairness, Osborne introduced the Lifetime ISA or the LISA as its being widely called.

Osborne has dubbed this as a ‘completely new flexible way for the next generation to save’.

Here’s how it works: From April 2017, anyone under the age of 40 will be able to open a Lifetime ISA and save up to £4,000 each year. For every £4 you save, the government will give you £1 up to a maximum of £4,000 a year – that’s £5,000 you can shelter from the taxman every year, until you’re 50.

Do the sums and you’ll see that over your lifetime you can put in contributions of £128,000 matched by a maximum bonus of £32,000 with investment growth on both your contributions and the government bonus.

The thinking behind the Lifetime ISA is that you don’t have to choose between saving for your first home or saving for your retirement. You can use the funds to buy a first home worth up to £450,000 or the funds can be withdrawn from age 60 to help fund your retirement. If you require the money for any other purposes, a 5% charge will be applied. You will have the accessibility of an ISA with the added incentive to put something away for your golden years.

When does a LISA make sense?

1. If you’re working for yourself

There are many advantages to being a freelancer/contractor/part-timer – you are the master of your own time, you don’t have to deal with any office politics and, if you’re lucky enough, you can work from the comfort of own home – slippers rather than suits.

But you will be forfeiting a company pension and additional employer contributions when it comes to your retirement planning.

For the self-employed, the government top-up offered by the LISA is a huge attraction – you won’t get that from the pensions system today.

2. If you’re a lower rate taxpayer (and most young people are)

It’s always sensible to stay in your workplace pension and get any employer contribution available. But saving in a pension beyond this level may be questionable. Generally anybody paying basic rate tax today will be better off making additional saving in a Lifetime ISA rather than a pension, as the table below illustrates.

  Your contribution The government top up/tax relief Total savings Tax to pay at retirement At retirement - how much you will get after tax
Pension £800 £200 £1,000 £250 (25% tax free) 20% on £750 = £150 £850
LISA £800 £200 £1,000 0 £1000

3. If you’re planning on buying your first home

If you have your eye on both saving for a house deposit and putting money aside for your retirement then you will definitely want to consider using the LISA. It is essentially free money and you can use it for a house purchase as soon as one year after opening the account.

Ideally you should be saving in a pension to get the employer contribution but in some circumstances you may prefer to forego that for the benefit of being able to access the funds early to buy a house. It’s also worth noting that the Lifetime ISA is more generous than the Help to Buy ISA with a higher annual allowance and larger government top-up.

  Annual allowance Government top-up Annual total Total over lifetime Total from government TOTAL
LISA £4,000/year £1,000 £5,000 £128,000 £32,000 £160,000
Help to buy ISA £2,400/year £600 £3,000 £12,000 £3,000 £15,000