Savers have taken to the ISA family. ISAs, provide a tax efficient way to save or invest, because they shelter the money you put in, and any interest or return it makes from the taxman.
You pay no Income Tax or Capital Gains Tax on your ISAs. In fact, you don’t even need to declare them on your tax return.
Last March, the then chancellor George Osborne recognised the public’s enthusiasm, and introduced a new member of the ISA family, the LISA or Lifetime ISA.
So, what is new about the LISA, how is it working so far, and should you think about having one?
As its name suggests, the Lifetime Individual Savings Account is primarily designed for long term savings. It’s tax efficient status is much like other ISA products, but it comes with an important new feature.
Savers can make annual contributions up to £4,000 which will earn a generous 25% bonus from the Government.
The maximum Government bonus is £32,000, payable if someone makes the full annual contributions from age 18 to the cut-off age of 50.
This sounds almost too good to be true. For every £1,000 invested or saved, the Government will provide a £250 top-up paid annually in the first year but monthly thereafter. This is on top of the interest your money should earn, and it’s all yours, tax-free. But there is a catch.
How you can use your money
You can’t simply dip into your LISA as you can with other ISAs. In fact, there are only three ways to use the money you have built up.
The first is to buy your first home. The rules allow first-time homebuyers to use the proceeds from a LISA as a deposit on a home valued up to £450,000. Money can be accessed on the plan’s first anniversary.
The second is to help fund your retirement. If you don’t use the LISA to buy a home, your contributions will continue to attract the 25% bonus until you are 50 with penalty-free and tax-free access once you turn 60.
The third is if you have been diagnosed as terminally ill.
You may also be able to access your money in a financial emergency, but the Government will claw back bonuses and some of the interest your LISA has built up.
Are people taking out LISAs?
LISAs are open to everybody between the ages of 18 and 40. The Government is hoping that with the top-up bonus, they will be a big help for people wanting to build big cash pots to use as a home deposit, and help others build up savings for their old age.
They have only been available for a month, and with the new tax year only just here, it’s too early to say if they are going to be as popular as the Government might wish. Certainly, there are some people who could do very well with a LISA, while others should probably avoid it.
As a way of building up a deposit for a first home, it’s hard to beat. You get that 25% extra from the government while you save.
But what if you already have bought. Does the LISA work for you then? Savers will be able to make contributions and receive a bonus from the age of 18 up to the age of 50. The government cash is the equivalent of a 25% interest rate on the money you put in. So you could end up with £32,000 worth of bonuses if you paid in the maximum £128,000 over 32 years.
Of course, most 18 year olds will have other ways to spend £4,000 a year. It may be more realistic to consider a 25-year-old who takes out a LISA and pays in £4,000 a year. Assuming the fund enjoys annual growth of 5% they could end up with a tax-free pot worth more than £416,000 at the age of 60.
This sounds like a good return, but most people might be better off making the most of their pension entitlement, which with higher rate tax relief and employer contributions could be even more rewarding. However, if you are already making pension contributions of the £40,000 annual allowance, a LISA might allow you to stash away more for retirement without the danger of running over the £1 million lifetime limit on your pension pot.
Should you have a LISA?
If you are aged between 18 and 40 and don’t own a home, a LISA might be a simple way to boost savings for a deposit. If you are already buying a home, the answer may not be so simple. It could have a part to play in your retirement planning under certain circumstances – especially as unlike a pension you could withdraw all your LISA savings as a tax-free cash lump sum.
Remember, though, the £4,000 you can invest in a LISA each year is part of your £20,000 annual ISA allowance.
Various providers have now launched LISAs or are planning to do so shortly. They include stock market investments as well as cash savings, adding another set of questions you need to ask if you want to consider a LISA.
The value of investments can go down as well as up and you may not get back the amount invested.