The full 25% lifetime Isa (LISA) withdrawal penalty will be back in the new tax year, the government has confirmed.
Last year, the 25% LISA withdrawal penalty was reduced to 20% for withdrawals made from 6 March 2020, to help savers struggling as a result of the coronavirus crisis.
Despite calls to extend the lower LISA penalty, the government plans to restore the 25% charge from 6 April 2021.
Here, Which? explains how lifetime Isas work, how much the penalty change will cost savers and looks at whether you should get one ahead of the new tax year.
How do lifetime Isas work?
The LISA is a tax-free account designed to help younger people buy their first home or save for retirement.
Adults aged between 18 and 39 can open a cash LISA, which will pay interest, or a stocks and shares LISA which could benefit from investment growth.
The government will pay a bonus worth 25% of what you pay in, up to £1,000 every tax year until you turn 50 years old.
Up to £4,000 a year is eligible for the 25% bonus (you can add more but it won’t receive a government contribution).
The amount you pay in is linked to your annual Isa allowance. For example, if you pay £1,000 into your LISA, you can still pay £19,000 into other Isa products such as a stocks and shares or cash Isa.
- Find out more: what is a LISA?
How much will the penalty increase cost savers?
The money saved in a LISA is meant to go towards the purchase of a first property or to help fund your retirement once you reach 60 years old.
If you withdraw money for any other reason, you will currently face a 20% penalty (or 25% from 6 April 2021) on the amount withdrawn.
The only exception to this is if you’ve been diagnosed with a terminal illness and have less than 12 months to live, in which case you can withdraw all of the funds (including the bonus) tax-free and penalty-free, regardless of age.
Below are two examples of what charges you will face under the 20% and 25% penalty.
- 25% LISA withdrawal penalty: you pay in £1,000 and receive a 25% government bonu,s taking your balance to £1,250. You choose to withdraw £1,250 for an unauthorised reason, so you’ll pay a £312.50 penalty, leaving you with £937.50.
- 20% LISA withdrawal penalty: you pay in £1,000 and receive a 25% government bonus, taking your balance to £1,250. You choose to withdraw £1,250 for an unauthorised reason, so you’ll pay a £250 penalty, leaving you with £1,000.
The 20% penalty effectively meant you only lost out on the government bonus if you needed access to your savings for an unauthorised reason. The 25% penalty will mean you will lose the government bonus plus 6.25% of your original investment.
So you should think carefully about whether a LISA makes sense for your circumstances in the new tax year.
Find out more: is there life in the Lifetime Isa?
Should you use a lifetime Isa for your first home?
If you want to buy your first home within the next year, you won’t benefit from a LISA, as funds can only be withdrawn after 12 months.
Otherwise, a LISA may be worth considering.
You can save more money and earn a bigger bonus compared with the Help to Buy Isa (which is no longer available to new applicants).
You’re also not limited by a monthly deposit cap – with the Help to Buy Isa you can only save £200 per month, but with the LISA you can add cash as a lump sum.
LISA bonuses can be used towards more expensive properties. With the Help to Buy Isa, you can only buy a house worth up to £250,000 (or £450,000 in London), while the LISA allows you to buy a home worth up to £450,000 anywhere in the UK.
You can also choose to open a LISA alongside a Help to Buy Isa. However, you can only use the government bonus from one of these accounts to buy your first home. You can transfer money in your Help to Buy Isa to a LISA, but this will count against the LISA contribution limit for that year.
- Find out more: how to buy a house
Is a lifetime Isa better than a pension?
The LISA offers an alternative for younger people who might otherwise save into a personal pension or a self-invested personal pension (Sipp).
But you might want to save into both – and the government has stressed that the LISA isn’t a replacement pension but rather an additional savings vehicle.
The lifetime Isa is likely to be the best option for you if:
- you don’t get the benefit of an employer pension contribution through a company scheme (for example, if you are self-employed);
- you’ve made the maximum tax-free contribution via your workplace pension and want to supplement your retirement savings.
A traditional pension is likely to be the best option for you if:
- you’re already in a workplace pension and your employer contributes (under auto-enrolment rules your employer will contribute at least 3%);
- you’re a higher-rate taxpayer (so qualify for pension tax relief at 40% or 41% in Scotland) and you are likely to be paying a lower rate of tax in retirement (say 20%) than you did in work;
- you want to make significant pension contributions past the age of 50. The lifetime limit for a pension is £1.073m, while the most you can contribute to the LISA is £128,000.
Find out more: LISA vs pension
How to open a lifetime Isa
To open and continue to pay into a LISA you must be a resident in the UK, unless you’re a Crown servant (for example, in the diplomatic service), their spouse or civil partner.
You should be able to apply online or call a provider’s customer services line if you’re stuck, for help over the phone.
There are currently 15 LISA providers on the market, offering either cash or stocks & shares investment options. These include the likes of Hargreaves Lansdown, Nutmeg and Moneybox.
You can read more about what each of them offers in our lifetime Isa guide.
source https://www.which.co.uk/news/2021/03/25-lifetime-isa-penalty-to-be-restored-in-april-is-it-still-worth-getting-one/