There are so many different types of investment and savings accounts on the market at the moment that it can be confusing deciding where best to allocate your money. Here, we investigate what a Lifetime ISA is with particular emphasis around their suitability for a pensioner and a pensioner’s specific requirements. Most crucially, we analyse a Lifetime ISA considering a pensioner’s short investment timeframe and need to protect capital.
What is a Lifetime ISA account?
A Lifetime ISA is a form of savings account designed to encourage people to save for their retirement or buy their first homes. People can pay into one up to a specific limit each year, currently set at £4,000. The money that they do pay in earns a 25% bonus paid by the UK government.
Bonus payments are currently capped at a £1,000 maximum a year. The government pays bonuses each month. However, it is worth checking what each provider’s Lifetime ISA does with the bonus payments. Some will reinvest the cash for you so that you can start earning interest on it. Others will simply put it aside for you in a non-interest bearing account.
There are strict criteria for when you can access your money without the steep penalties. These penalties are in place to encourage savers to use a Lifetime ISA as a long term savings strategy to help boost house deposit pots and retirement funds.
How does a Lifetime ISA work?
While the idea around a Lifetime ISA is quite simple - you pay money in and earn interest plus a 25% bonus - the rules surrounding when and how you access the funds you do save are quite strict.
Firstly, you can only open a Lifetime ISA if you are between 18 and 40. You can still pay into your Lifetime ISA up to the age of 50, and continue to receive bonus payments in that time. Secondly, the £4,000 limit that you can pay in comes out of your total annual ISA allowance, which currently stands at £20,000 for 2020/21.
When you want to use your Lifetime ISA, you need to either be over the age of 60 or buying your first home. If it is for the latter, there are again several requirements you need to meet before being able to access your funds penalty-free.
- You must be a first-time buyer. You cannot ever have owned a home anywhere else in the world.
- The home you are buying cannot cost any more than £450,000 (as of 2020/21)
- You have to be buying the house to live in as your primary residence.
- Your mortgage must be on a repayment basis structure.
The other circumstances in which you can access your cash without incurring a penalty are when you reach 60 or if you are diagnosed with a terminal illness. If you take money out of your account for any other reason than these or buying your first home, you will have to pay a penalty. That penalty is hefty - 25% of what you want to withdraw. This means that you can end up losing some of the value of your original investment if you access your money outside of the allowed terms.
For example, if you have paid in £500, your cash will have grown to £625. If you want to withdraw that, you pay a 25% fee of £625 which amounts to £156.25, so you would only receive £468.75 back.
These products have been structured in this way to ensure that they are only used for buying a first home or for retirement.
Benefits of a Lifetime ISA
There are some substantial benefits to be gained from a Lifetime ISA, which need to be weighed up with their disadvantages to see whether it is a suitable investment for you.
The bonus payments paid by the government are not to be sniffed at. Gaining an extra £1 for every £4 you save is a healthy reward. While capped at £1,000, those bonus payments can add up and make a significant difference if you are using the scheme to save for retirement or your first home.
On top of the fact that you are not only receiving bonus payments on your investment, you also gain interest on your original investment and the bonus payments too. This can add up to a substantial amount of cash helping to grow your funds.
Notably, the interest that you do earn on your savings is tax-free. That is true for both the bonus payments and the final interest amount you earn too - helping boost your savings even further.
Annual or monthly payments
If you want to open a Lifetime ISA, it is good to know that you don’t have to open it with one large lump sum in the first instance. You can open it from as little as £1 with some providers, plus you can also often choose to pay in monthly or annually - depending on your circumstances. This flexibility can be beneficial to some and means you can start earning interest on a savings account immediately.
Disadvantages of a Lifetime ISA
There are obvious drawbacks to a Lifetime ISA, particularly if you are a pensioner. It is imperative to keep these in mind when planning for your retirement so that you do not budget incorrectly, causing financial hardship in the future.
Hefty Penalty Withdrawals
The purpose of Lifetime ISAs is to encourage saving for buying a first home and retirement. For that reason, they have a stringent set of restrictions that can make them unsuitable for some. The implications of those restrictions mean the severe penalty withdrawal charge can materially impact the value of what you receive should you need to withdraw your cash outside of the three allowed reasons.
Long term investment
This is an investment to be made over the long term. While saving is always a healthy habit to get into, this is an investment with a very long term horizon. Opening an account to save your funds at 40, which you cannot access without incurring a penalty charge until you are 60, is a big decision to make. So much can happen in a person’s life in those 20 years that you have to be incredibly sure that this is the right investment for you.
Who is allowed to open a Lifetime ISA account has a significant impact on who it is suitable for in the first place. Sadly, those past the age of 40 are not able to open such an account, hindering many who may be tempted by the bonus payments and tax-free benefits.
Is a Lifetime ISA worth it?
As ever, your specific needs will determine whether a Lifetime ISA is worth it. Pensioners often need to protect their capital, but also need to access their cash as and when they need. However, you may also need to make up for the shortfall in your pension budget between income and outgoings, so a product that offers a 25% bonus on what you pay in is a big draw. Additionally, the fact that it is a relatively safe investment given that it is backed by the government is a comfort.
Sadly, however, the eligibility criteria for Lifetime ISAs may prevent and stop many pensioners from even being able to open such an account at all. Those over the age of 40 cannot open a Lifetime ISA, and those over the age of 50 can no longer pay into a Lifetime ISA they have opened. Ultimately, it is this sticking point that may preclude pensioners from even being able to consider if a Lifetime ISA is worth it in the first place. So, while these can make for good savings accounts for retirement - if your retirement is imminent, you may be forced to look elsewhere.
We approached Karen Brolly, Partner at Hymans Robertson LLP, who told Pension Times: "If we consider those who are still saving towards retirement, then I think the additional point that should be made is that those approaching 40 should take a LISA out – even with a minimal contribution initially.
"This then gives them a 10-year period in which to make contributions and benefit from the bonus. Since the 40-50 age band is a key time for pension accumulation, it is good to consider the LISA as an additional route for adding to overall savings, assuming max matching has been achieved from any employer pension scheme that they are in.
"Approaching 40, individuals may not feel that they have much spare each month to contribute to savings, but that could change over the next 10 years and if they don’t take out the LISA before 40 then they lose the chance to do so. The other point that hasn’t really been mentioned is the wider point that applies to all ISAs – and that is the funds can be taken tax-free – so many retirees will look to build their retirement income from a mixture of pensions and ISA savings in a way that keeps income tax to a minimum."