Treasury Committee clashes with Government on lifetime ISA reform timing

As far as snippy comments go, this was a good one.

The Treasury Committee recently vented its frustration that the Government had not heeded its warnings that the lifetime ISA needs reforming.

This spat started when the Treasury Committee conducted an inquiry earlier this year looking at whether lifetime ISAs are still an appropriate financial product nine years after they were created. It invited comment from the industry and other stakeholders and held a couple of oral evidence sessions.

Both were entertaining watches. In one the participants strongly disagreed with each other. In the other, with Emma Reynolds (who was Economic Secretary to the Treasury at the time), the Committee didn’t bother to hide its annoyance that HMRC research wasn’t ready to feed into its inquiry.

In the final report, published in June, MPs criticised the dual-purpose design of the lifetime ISA, arguing that it may be diverting people away from more suitable products and putting part of their savings at risk. It concluded that the lifetime ISA needed reforming.

HMRC finally published its research on lifetime ISAs earlier this month. Spanning both data gathering, as well as more in-depth conversations with lifetime ISA account holders, this was an interesting insight into how people are using the tax wrapper in practice. What was clear was that, although it wasn’t widely used, the people who did have one liked it. Almost all (96%) found it easy to set up and make withdrawals from (87%). And almost 80% said the government bonus had been either essential or important when buying their first home.

But despite this, the research showed there are several design flaws that need to be improved to ensure more people to take out a lifetime ISA and help them to save for a first home or retirement.

The dual objective isn’t really working. The research showed people took out a lifetime ISA to either save for a first home or for retirement. Only a handful took it out with both objectives in mind.

But a bigger flaw is the penalty for chargeable withdrawals. This is 25% of the withdrawal if it wasn’t to pay for a first home, and the account holder is younger than 60 and not in severe ill health. This not only recoups for HMRC the bonuses it paid out but also gives them a cut of 6.25% of the individual’s own funds. This is to act as a deterrent; to put them off withdrawing.

The research showed most people took an unauthorised withdrawal with their eyes wide open. They knew the risks, but they went ahead despite the charge. This could have been for many reasons, but the research shows those who made unauthorised withdrawals were more likely to be struggling financially.

Even the best-laid plans often go awry, and it is unfair to punish people with an exit charge that goes beyond simply recovering the government-funded bonus. The research showed the charge was putting people off taking out a lifetime ISA in the first place. Reverting to the system used during the pandemic, when the penalty only matched the original bonus received on the account, would be a fairer approach.

Not many would argue that lifetime ISAs don’t need reforming. But the timing of any review is at the heart of the fall out between the Treasury Committee and the Government.

The Treasury Committee was looking for a quicker response from the Government. Whereas the Government has already undertaken to look at options for reforming ISAs on a broader level, to encourage more retail investing.

We can only hope that while the Government has got ISAs on the examination table, it extends this review to also include proposals to reform lifetime ISAs.

It may be that the Treasury Committee, like the rest of us, has to sit patiently and wait until the end of the November and the Autumn Budget to find out if the Government has been paying attention to its report and will propose improvements to lifetime ISA rules.