On 6 April 2021, the withdrawal charge on Lifetime ISAs (LISAs) reverts to 25%, having been payable at a reduced rate of 20% since 6 March 2020. The charge is intended as a deterrent to those accessing their LISA for a purpose other than those the product is designed for – namely first-time house purchase or income in retirement – and, at the 25% rate, includes a penalty as well as recouping the Government bonus.
So, who should consider a LISA and how does it work?
A LISA can be opened by any UK resident (or UK Crown employee) from their 18th birthday until the day before they turn 40. Importantly, the LISA must also be funded before their 40th birthday – so opening an account but not paying any money in until after the big 4-0 doesn’t work. Like most ISA types, you can only open and fund one in each tax year, although there is no limit on how many you can hold.
How does the bonus work?
All payments made into a LISA receive a 25% bonus. Up to £4,000 can be paid each tax year – so a maximum bonus of £1,000 will top that up to £5,000 in the account which can be invested.
It is important to note that the £4,000 limit sits within the overall £20,000 ISA allowance, not on top of it. So, if the full LISA allowance is used, there is £16,000 left that can be paid into other ISAs such as a stocks and shares or cash ISA.
It is also possible to transfer in monies from other ISAs to a LISA, up to the £4,000 a year, and get the bonus. This will use up the LISA allowance, but does not use up any of the £20,000 overall ISA limit as the monies were already in an ISA wrapper. Just remember that, as with any ISA transfer, you can’t split current year subscriptions.
The LISA manager will automatically request the 25% bonus from HMRC on the 6th of the month for all money paid in over the previous month. The bonus is received four weeks after that, meaning bonuses will be received into the account between four to eight weeks after money is paid in, depending on the date the subscription was made.
There is no option to pay more than £4,000 into a LISA and not get the bonus on the excess – everything that goes in must qualify (except for LISA-to-LISA transfers).
Although it is only possible to open a LISA before turning 40, once open payments can continue until the day before the 50th birthday. This means if someone opened a LISA at age 18 and paid in the maximum of £4,000 each tax year until they turned 50, they could claim a grand total of £33,000 in Government bonuses (unless their birthday is 6 April).
Those approaching their 40th birthday who are unsure whether they want to open a LISA may want to consider opening an account with a minimum subscription just to keep the option open to pay in over the next 10 years.
What can it be used for?
LISAs have been designed with two specific, but unrelated, purposes in mind. One is to help fund a first-time property purchase, the other is as a quasi-pension to provide income in retirement. If withdrawals are made for other purposes in the account holder’s lifetime, then a penalty applies. The only exception is for those with less than 12 months to live.
There are a few criteria for using LISAs for property purchase, so care is needed to avoid tripping up.
First, the LISA needs to have been funded for at least 12 months before a charge-free withdrawal can be made. It is important that account holders are aware of this if they are planning a property purchase in the near-term. If you have clients under 40 who are potentially looking to buy on a first-time basis, then they could consider opening a LISA with a minimum deposit to start the clock ticking, even if they only put in the balance to £4,000 once they’ve found a property to buy.
In terms of the property itself, it must be in the UK with a purchase price of £450,000 or less. Unlike with the help-to-buy ISA, there is no differential between London and the rest of the country. There must be a mortgage being used to purchase the property and the LISA holder must be intending to live in the property on completion. The only exception to this last rule is for Crown employees working abroad, who can purchase UK property to let on condition that they use it to live in when they return to the UK.
The LISA holder cannot have owned property previously – be that in the UK or anywhere else in the world. This includes property they have inherited and is regardless of how small a share of the property they may have had.
It is possible for two or more people to come together to purchase the property. It is only the LISA holder that needs to be a first-time buyer, so if they wish to purchase a property jointly with a partner who has previously owned, this does not stop them using their LISA for their share.
If property is being purchased between two or more people who are all LISA holders and who are first-time buyers, then they can all use their LISAs to help with the purchase. One advantage the LISA has over the help-to-buy ISA is that, as the bonus is paid monthly, it can be used for the deposit of the property at exchange. With help-to-buy, the bonus is only claimed after exchange and so just reduces the size of the mortgage. It is also worth noting that the LISA and help-to-buy ISA cannot both be used by the same individual.
When the LISA is used to purchase property, the withdrawal is paid to the account holder’s conveyancer. Once the payment is made, the purchase should be completed within 90 days (it may be possible to extend this up to 180 days if required). If the purchase falls through, the payment must be returned in full to the LISA immediately. If there are any shortfalls, these must be explained by the conveyancer.
There is no requirement for the LISA to be closed once the withdrawal has been made. It can remain open and accept further subscriptions which can then be accessed charge free from age 60.
LISA v pension
Once the account holder celebrates their 60th birthday, they can access their LISA funds freely. Like all ISAs, withdrawals are tax-free so this can make them an attractive alternative to a pension, albeit one you have to wait a few years longer to access. Although for the youngest account holders, access to pensions may have caught up to age 60 by the time they get there.
When looking at LISA v pension, for most this should only really be considered for funds over and above minimum auto-enrolment (AE) contributions. If you opt out of AE to pay into a LISA, the valuable employer contributions are lost. When looking at LISAs as a vehicle for retirement income, this is unlikely to be a wise move.
The situation when looking at LISAs v pensions once AE minimums are met is slightly different, though.
The upfront bonus is the same for both products, although marketed differently: 20% basic rate relief in a pension or 25% bonus on a LISA. Either way, if £4,000 goes in, HMRC will add an additional £1,000.
When it comes to making withdrawals, only 25% can be taken tax-free from a pension, with the rest subject to Income Tax, compared to all tax-free from a LISA.
If taxable pension withdrawals are taken within the personal allowance, it is possible pensions and LISAs will deliver a similar level of income. However, if pension withdrawals are above the personal allowance, it is likely the LISA will be more tax efficient.
However, the situation changes for higher and additional-rate taxpayers, (and intermediate taxpayers in Scotland), as they can claim the extra tax relief, whereas the LISA bonus is a flat rate for all.
Let’s not forget, too, that pensions are usually outside the estate on death, unlike ISAs.
Really the question is not LISA v pension – as often the answer is both. For those with more than £4,000 a year to invest, the LISA will not be sufficient. A pension has a much higher annual allowance (£40,000 for most), giving much more potential, but a LISA can be useful for those who have used their pension annual allowance or all their entitlement to higher rate relief, or who may potentially breach the lifetime allowance.
It’s also worth remembering that LISAs do give flexibility to access funds early – albeit with a penalty – if really needed.
When the penalty applies
When the LISA was introduced, the withdrawal penalty was set at 25%. At first glance this looks like it simply claws back the 25% bonus, but simple analysis shows this is not the case.
If the maximum £4,000 is paid in, the 25% bonus is £1,000, so there is £5,000 in the account. When the full amount is withdrawn, the 25% charge is applied to £5,000, so £3,750 is returned to the account holder with £1,250 sent to HMRC by the ISA manager.
In the wake of the pandemic, the Government recognised that LISA savers may need to access funds, and from 6 March 2020 until 5 April 2021 the rate was cut from 25% to 20%. At 20%, the charge is a simple reclaim of the Government bonus.
In the recent Budget, several pandemic-related support programmes were prolonged, and it was perhaps disappointing that the reduction in the LISA withdrawal charge was not one of them. With the inevitable removal of furlough, there will be many that may find themselves forced into withdrawals in 2021/22 at the higher rate of 25%. Of course, it could be argued that a simple clawback of the Government bonus would be fairer regardless of the pandemic.
This article was previously published by FT Advsier
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