Over the Christmas holidays, I spoke with friends over dinner about saving for their first homes. As we exchanged stories of budgets, unexpected expenses, and sky-high property prices, the Lifetime ISA (LISA) came up, says Aaron McAuley, paraplanner at GSB.
The discussion praised its 25% government bonus, however there were a few negative topics including the penalties associated with accessing the funds and how rigid the scheme is, with the £450,00 property value cap as an example.
This left me wondering, is the LISA still fit for purpose? Or is it time to rethink this savings vehicle?
As part of an inquiry into the LISA, the Treasury Select Committee is gathering evidence from the financial sector and consumers to assess whether the product’s benefits outweigh its drawbacks. From my side, reform is the answer.
Introduced in 2017, the LISA was designed to encourage younger people to save for their first home or retirement. However, its design flaws and limited effectiveness leave much room for improvement.
The Benefits: A Bonus Worth Grabbing
At its core, the LISA’s main appeal lies in the 25% government bonus. For every pound you save (up to £4,000 annual limit), the government adds 25p. This means that someone who maximises their contributions can enjoy an extra £1,000 each year, a significant boost, especially for first-time buyers struggling to save in today’s economic climate.
Additionally, the LISA’s tax advantages are worth noting. Like other ISAs, interest or investment growth within the LISA is tax-free. I would argue that for young savers starting early, this can result in a meaningful nest egg, whether for a first home or retirement.
The Drawbacks: Unintended Penalties and Restrictions
Despite its apparent benefits, the LISA has come under fire for its somewhat harsh withdrawal penalty. If funds are withdrawn for reasons other than purchasing a first home, reaching age 60, or terminal illness, a 25% penalty is applied to the total amount. While this might sound like merely losing the government’s bonus, it actually results in a net loss of 6.25% on your contributions.
For example, if you saved £8,000 and received a £2,000 bonus (totalling £10,000), withdrawing the entire amount would leave you with only £7,500 after penalties, a net loss of £500.
In 2023-24, 99,650 individuals made ‘unauthorised withdrawals,’ leading to total charges of £75.2 million. I believe this penalty is excessively punitive, particularly in cases of financial hardship. During the COVID-19 pandemic, the penalty was temporarily reduced to 20%, and I would say this reduction should become permanent.
Housing Crisis: Does the LISA Keep Up?
Another contentious aspect of the LISA is the £450,000 property price cap, which limits its usefulness in regions with high housing costs. According to the ONS’s latest housing price bulletin, average house prices in the UK have risen significantly, particularly in London and the South East.
I believe the current cap feels outdated and unfit for today’s housing market. Raising the cap to reflect inflation or regional variations is essential to ensure the LISA remains relevant for first-time buyers.
A Pensions Alternative? Not Quite
The LISA’s dual-purpose design, i.e., saving for a home or retirement, has also been criticised for lacking clarity and complementarity with existing pension products.
While the government bonus is attractive, I would point out that workplace pensions offer better incentives, particularly for those with employer contributions. A 25% LISA bonus pales compared to employer-matched pension schemes’ potential 100% return (or more).
In my opinion, the LISA’s rigid rules and lack of tax relief on contributions make it less flexible and less competitive compared to pensions as a retirement savings option.
Simplifying the product and clarifying its intended purpose could help resolve some of this confusion.
Reform Is the Way Forward
Rather than abolishing the LISA, I believe reforming it could unlock its full potential. Key changes could include:
1. Reducing or Removing the Withdrawal Penalty: Lowering the penalty to 20% (as seen during the pandemic) or eliminating it entirely would make the product more forgiving for savers facing financial difficulties.
2. Raising the Property Price Cap: Adjusting the £450,000 limit to reflect regional variations and inflation could significantly increase the LISA’s appeal to first-time buyers.
3. Increasing the Annual Contribution Limit: Boosting the current £4,000 cap could make the LISA a more competitive alternative to pensions for retirement savings.
4. Improving Public Awareness: Simplifying the product’s rules and increasing outreach efforts could help more young people understand and utilise the LISA effectively.
Conclusion: Abolish or Evolve?
The debate over the Lifetime ISA is unlikely to end anytime soon. While it offers clear benefits, such as the government bonus and tax advantages, its flaws cannot be ignored.
I firmly believe targeted reforms are the solution, not abolition. The LISA could become a much more effective tool for savers with changes to address its punitive penalties, restrictive property price cap, and public awareness issues.
For policymakers, the choice is clear: evolve the LISA into a genuinely supportive savings product or risk losing its potential altogether. I believe in its ability to succeed with the right reforms.
By Aaron McAuley, paraplanner at GSB
