Investing for your first home or retirement? A guide to Lifetime ISAs

Younger people face tough decisions when it comes to making the most of their money. Many will be trying to save enough to buy their first home, while being aware that it pays to ‘start young’ when building longer-term financial security, via pensions and retirement funds.  

The good news is a Lifetime ISA can help them to get started on the path towards both goals. Our guide below explains how this tax-efficient product works in more detail. 

What is a Lifetime ISA?  

The Lifetime ISA (LISA) is the most recent addition – launched in 2017 – to the range of Individual Savings Accounts, specifically aimed at younger adults. In some ways, it could be seen as a cross between a traditional pension and an Individual Savings Account (ISA).  

Those putting money to work in a LISA receive a 25% government bonus on contributions up to the annual limit, broadly similar to the 20% basic-rate tax relief paid on pension contributions. However, unlike a pension, investors can access their money before retirement provided it is used to purchase their first home.  

Money that isn’t used towards a first home can go towards a retirement pot, and be accessed, without paying income, dividend or capital gains tax, from the age of 60. 

In this article, we are primarily talking about investing in a stocks and shares LISA – such as offered by Nutmeg – which invests in equity and bond markets. Remember, as with all investments, there is no guarantee of returns and you may get back less than you put in. 

If you are not comfortable with investing, other providers offer a cash version of the product, where money may earn interest rather than being invested.  

How much can I invest in a Lifetime ISA? 

Like others in the ISA family, LISAs are tax-efficient products. But with a LISA, for every £1 you contribute, the government adds an extra 25p. Given this is a generous bonus – and essentially ‘free’ money – there are limits on who can take out a LISA and how much they can invest.  

Top open a Lifetime ISA, you must be a UK tax resident over the age of 18 and under 40 years old. Investors can contribute up to £4,000 per year in a LISA, which will boost the funds invested by an extra £1,000 if you make the maximum contribution. Investors are free to contribute to their LISA until their 50th birthday, after which no further payments are allowed.  

When can I access my Lifetime ISA money?  

With a stocks and shares ISA, investors are free to take out their money at any time and spend it on whatever they want – though investing on a long-term time horizon with a specific goal in mind is recommended.  

This is not the case with LISAs. Investments are earmarked for a house purchase or retirement — and there will be an exit penalty to pay on other withdrawals. 

You can access LISA money, penalty-free in the following circumstances: 

• Buying your first home 
• After your 60th birthday 
• If you are terminally ill 

Those accessing their money outside of these cases will pay a 25% withdrawal charge. This not only claws back the government bonus, but also reduces the value of your investment.  

For example, if you’ve invested £4,000 and received the 25% bonus, you’d have a LISA fund of £5,000. But if you then withdraw this money in full for any different reasons than above, a 25% penalty charge will be applied, reducing your investment by £1,250. This means you will only have £3,750 to spend, which is less than you put in.  

For this reason, it is important to build up emergency savings in other products, such as cash ISAs.  

How Lifetime ISAs can fast-track getting on the housing ladder 

LISAs are designed to help younger investors looking to build a nest egg that will allow them to buy their first home. It’s important to remember that these can only be used by prospective first-time buyers — not those who already own a property and are looking to move up the housing ladder. It’s also important to note that the property must be one you intend to live in, it can’t be a buy-to-let property. 

For people looking to buy their first property as a couple or with a friend, provided neither party already owns a property they can both use a LISA. This effectively means a couple, if they have enough surplus cash, can invest £8,000 a year, which will be boosted to £10,000 with the government bonus.  

Note that you can only use these LISA investments to buy a property that costs £450,000 or less. You must also have had the LISA for at least 12 months before you can use the funds to buy a property.  

How can a Lifetime ISA build a better retirement? 

A LISA can offer a flexible and tax-efficient way to start investing for later life. However, for many people, it is also worth investing in a pension alongside a LISA. Pensions have a more generous annual allowance — of up to £60,000 per year from 6th April 2023 — so there is the opportunity to accumulate a more substantial fund.  

If you have access to a workplace pension scheme your employer will also make contributions, on top of the government tax relief. These can significantly boost the value of your retirement pot. This is particularly true for higher-rate taxpayers, who benefit from more generous levels of tax relief. Note that tax treatment depends on your individual circumstances, and you may wish to seek specialist advice.  

To sum up, LISAs may be a relatively new product, but they offer some attractive features for those in their 20s and 30s who are trying to get on the property ladder, although strict rules around withdrawals mean they are not suitable for rainy-day savings funds.  

They can also be a useful addition, alongside pensions, for those looking to build longer-term retirement funds.  

Want to learn if a Lifetime ISA is right for you? 

To discuss how to manage both longer-term and more immediate financial goals, you can book a free call with one of our experts. They can explain investment products in more detail.  

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest.

A stocks and shares Lifetime ISA may not be right for everyone and tax rules may change in the future. You must be 18–39 years old to open one. If you need to withdraw the money before you’re 60, and it’s not for the purchase of a first home up to £450,000, or a terminal illness, you’ll pay a 25% government penalty. So you may get back less than you put in.

Compared to a pension, the Lifetime ISA is treated differently for tax purposes. You may be better off contributing to a pension.

If you choose to opt out of your workplace pension to pay into a Lifetime ISA, you may lose the benefits of the employer-matched contributions.

If you are unsure if a Lifetime ISA is the right choice for you, please seek financial advice.