Lifetime ISA: find the best for you

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Fact Checked.
Updated on
August 14, 2022

In a nutshell

Saving for your first home can seem like an impossible task. But with a Lifetime ISA, you can hit your savings goal a lot quicker thanks to a 25% government bonus on money you put in each year. You could use a LISA for a little extra for later in life too.

Nutty

You might know that an ISA is an Individual Savings Account (and if you didn’t know that, check out our ISA guide). But what is a Lifetime ISA?

Well, if we told you that for every £1 you save the Government would give you a 25% bonus, would you be interested?

Lifetime ISA (LISA)

We see you nodding! Let’s dive in and learn more about who can open a Lifetime ISA, how they work, the different types, and the all-important rules.

The 2 uses of a Lifetime ISA

There are only two ways to use your Lifetime ISA – there’s always a catch isn’t there?!

You can either put it towards the purchase of your first home, or you can use it to save for later in life (over 60) – but it’s not intended as a replacement to a pension.

How to use your Lifetime ISA

1. Using your Lifetime ISA to buy your first home 

You’ll be pleased to hear you can use your Lifetime ISA as a deposit on your first home! But there are a few rules:

  • You must be a first-time buyer. That means you can’t currently own (or have previously owned) a home in the UK — or anywhere else in the world, for that matter. 
  • You can’t buy a property worth over £450,000. 
  • You have to live in the home you’re planning to buy. In other words, you can’t buy somewhere to rent it out.
  • You must use a traditional repayment mortgage, where you repay the loan plus interest every month (so not an interest-only mortgage, for example). Learn more about mortgages here
  • Your Lifetime ISA account has to have been open for at least 12 months before you buy your home.

What if you’re buying a property with someone else?

If you’re buying a home with your partner (and you’re both eligible for a Lifetime ISA), you can get a Lifetime ISA each – doubling the amount of money you get free from the Government, and making it easier to buy your dream home quicker.

2. Using your Lifetime ISA to save for later in life

A LISA can act as a bonus to your pension savings if you want to save even more cash for later in life. But it’s not a replacement for a pension (here's our comparison of a Lifetime ISA vs pension). A pension has more benefits, which are:

  • You can pay in much more each year (£40,000) and over your lifetime (£1,073,100). The limit on a LISA is £4,000 per year (which is part of your overall ISA limit of £20,000).
  • You get the government bonus on your pension too. If you’re a basic rate tax payer (earn less than £50,271 per year), you’ll get 20% tax relief on your pension, which is actually the same as the 25% government bonus on the LISA.

How is it the same? Well you’ll normally be making contributions to your pension from your salary before you pay tax on your salary, which means you don’t pay tax on your pension contributions, you get 20% ‘tax relief’.

Whereas with a LISA, your contributions aren’t taken from your salary, you add it in yourself on money you’ve actually already paid tax on from your salary.

Let’s say you are paying £80 into your LISA, a 25% bonus on £80 is £20, making a total of £100. With a pension, you’ll have £100 taken from your salary before you pay 20% tax, which means you’re getting that 20% for free – and 20% of £100 is £80. So, exactly the same!

  • If you’re a higher rate tax payer (meaning you earn more than £50,271 per year), you will get 40% tax relief on your pension contributions on everything you earn over £50,271 – as that’s how much you would be paying in income tax. Much  better than the 25% LISA bonus.
  • If you are employed, your employer will make contributions to your pension too – at least 3% of your salary.
  • You can start withdrawing your money at 55 years old with a pension, rather than 60.

If you are self-employed, a LISA can appear to be an easy way to save for retirement, as you don’t have an employer to set up and manage a pension for you.

However, these days, pensions for the self-employed are super easy to set up by yourself, and you also get a 25% government bonus on your contributions too, automatically applied. 

Plus, the fees charged by ISA providers and the investment funds (the experts who manage your money) are normally cheaper with a pension than a LISA. Your pension is also managed by experts who specifically work on growing your money over time ready for your retirement, so you can be nice and comfortable when you retire.

We strongly recommend setting up a pension rather than a LISA if you are self-employed, and recommend reading our guide on self-employed pensions too. And use a LISA if you think you might want some extra money later in life.

Withdrawing money from your Lifetime ISA

If you take your cash out for any other reason than to buy your first home, or before you are 60, you’ll need to pay a withdrawal charge. Think carefully before you do. The charge is set at 25% of the amount withdrawn, hefty! 

You might be thinking, “well I’ll just be losing the government bonus”, which is 25%, but you’ll actually be charged more than you put in. Let’s take a look at an example: 

  • Say you’ve saved £2,000 and you want to withdraw your money after two years. That means you’ve got £2,500 in your account thanks to the 25% government bonus.
  • A 25% government withdrawal charge on £2,500 is £625, which would leave you with £1,875 – less than what you’d saved initially!

With this in mind, you should only open a Lifetime ISA to help buy your first home or to boost your savings for retirement. If you’re saving for any other reason, check out one of these ISAs instead.

However, as part of the Lifetime ISA rules, if you fall terminally ill, you can withdraw cash from your Lifetime ISA provider without having to pay the government penalty (25%). Even after you’ve received a Lifetime ISA bonus (or a few bonus payments), and earned interest or investment growth.

Who can open a Lifetime ISA? 

To open a Lifetime ISA, you have to be: 

  • Aged between 18 and 40, and
  • A UK resident.

Heads up: If you’re a Brit abroad, you can only open a LISA if you’re a Crown employee (a member of the UK armed forces, a civil servant, or a diplomat).

How do Lifetime ISAs work? 

Lifetime ISAs are pretty similar to other types of ISA — you can save or invest your money, and you don’t have to pay any tax on the money your savings/investments make. Which is great, as tax can have a huge impact on the speed at which your money grows.

ISA never pay tax

So far, so simple. But there are a few key differences worth noting when it comes to LISAs:

  • You can only pay a maximum of £4,000 into your Lifetime ISA each tax year (which runs from April 6 to April 5 the following year).
  • For every £1 you save, the Government pays you a 25% bonus into your Lifetime ISA account. This bonus is paid monthly, and all done automatically.
  • The maximum bonus you can earn in a tax year is £1,000 (25% of £4,000).
  • You can only pay into a LISA up to the age of 50.

This means if you’re able to save the full £4,000 into your Lifetime ISA in the tax year, you’ll have £5,000 (plus any interest or returns on investment earned) to put towards your first property purchase or later in life. Sweet! 

Does paying into a Lifetime ISA affect your ISA allowance?

The ISA allowance is the amount you can save or invest without paying any tax. It’s set at £20,000 for 2022/23. 

You’re limited to what you can put into a Lifetime ISA each tax year (£4,000), and that number is linked to your overall annual ISA allowance. 

So, for example, if you save the full £4,000 into your Lifetime ISA, the most you can pay into your other ISAs is £16,000. 

Does paying into a Lifetime ISA affect your ISA allowance?

You can only open and pay into one of each type of ISA each tax year. The 2 main types of ISAs are Cash ISAs and Stocks & Shares ISAs. We recommend Stocks and Shares ISA as you’ll make a lot more money over time! (Learn more about Cash ISAs vs Stocks & Shares ISAs.)

The different types of Lifetime ISAs

There's 2 types of Lifetime ISA, you can choose to save (Cash Lifetime ISA) or invest (Stocks and Shares ISA) your money with a Lifetime ISA.

Cash Lifetime ISA

This type of ISA lets you save cash and earn interest tax-free. All you need to do is start saving! And you’ll magically get the 25% government bonus every month. The company running your ISA will handle everything for you (called Lifetime ISA providers). 

At the moment interest rates are really low, you’d only really get around 0.6% interest per year! The only benefit for using a Cash Lifetime ISA is to get the 25% government bonus. If you are saving for longer than a few years, a Stocks and Shares Lifetime ISA will grow your money far more.

Cash Lifetime ISA vs Stocks & Shares Lifetime ISA

Stocks & Shares Lifetime ISA

This type of ISA grows your money over the medium-to-long term (and can grow quite large!). Your ISA provider (the company managing your ISA), will work with an investment fund who will invest your money in things like stocks & shares, funds, and bonds. Don’t fear – your money is in expert hands, plus everything is handled for you too – you just put your feet up and watch your money grow.

Stocks and shares, eh? Tell me more… 

  • Stocks & shares: This is where you buy an ownership stake in a business, called a share (meaning you own part of the company). These shares are traded on a stock exchange and their value represents a share of the total value of the company. (the company value is normally based on how well they are doing as a business).

  • Bonds: Buying bonds is like loaning your money to a company or government – just like a loan you’d get from a bank. You receive interest payments on the amount you’ve loaned. The bond then “matures,” which is when the loan amount is repaid (plus interest payments over time).

  • Exchange-traded funds (ETFs): A fund is a group of different company shares grouped together, which allows anyone to simply buy a share of the fund rather than individual company shares – such as the top 100 companies in the UK. These types of funds can be bought and sold on a stock exchange too (traded).

When you invest in a Stocks & Shares Lifetime ISA, your ISA provider (the company that looks after the ISA) will work with an investment fund(s) who will manage your investments, such as buying and selling shares, to grow your money over time. All you need to do is sit back and relax.

If you start investing early, it’s almost certain that your Stocks & Shares Lifetime ISA will vastly outperform a Lifetime Cash ISA over time. And, all the money you start making from the investments will be completely tax free.

Can I have a Lifetime Cash ISA and Lifetime Stocks & Shares ISA at the same time?

You can indeed, but you can only open one Lifetime ISA in a tax year, and you can only pay into one Lifetime ISA each tax year.

So, you could open a Lifetime Cash ISA this tax year, pay into it, then open a Stocks & Shares Lifetime ISA next tax year, and pay into that. But you couldn’t split your money between the two in the same year.

With that in mind, you might be better off picking one type and sticking with it – if you think you’ll use the cash soon to buy a home, you could go with a Cash Lifetime ISA and just collect the 25% bonus.

The interest rates on all Cash ISAs are so low at the moment, around 0.6% on average, that you won’t actually make money in interest. In fact, as inflation is around 5%, which is a measure of what your money can actually buy, such as food and household bills, your money will actually lose value by saving cash. For example, food and bills will increase by 5% this time next year, but your cash will only be worth 0.6% (your interest), and so you are losing 4.4% (5% minus 0.6%) in the ability to buy things with your money.

However, if you’re not planning to buy a home for a while, such as 3 years or more, or want to use a LISA to save a bit extra for your retirement, you could go with a Stocks and Shares Lifetime ISA, so you can collect the 25% bonus, and grow your money over time too, with a rough estimate of 8% increase per year over time.

Note: You can open up different types of ISA that aren’t Lifetime ISAs in the same year. For example, you can also open a standard Cash ISA or a Stocks & Shares ISA. 

How do you open a Lifetime ISA?

Opening a Lifetime ISA is super simple. So long as you’re eligible (18-40, UK resident), all you need to do is decide if want a Cash Lifetime ISA (for short-term saving) or a Stocks and Shares Lifetime ISA (for long-term saving). 

Next, all you do is pick your preferred Lifetime ISA provider – they’re the people who manage everything for you. Not sure where to look? Don’t worry we’re to help you choose too.

For Cash Lifetime ISAs we recommend:

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Moneybox

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For Stocks and Shares Lifetime ISAs we recommend:

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Best Stocks & Shares Lifetime ISA

Nutmeg

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Let’s recap

A Lifetime ISA can be a massive boost to your savings if you’re a first time buyer – you can put your savings towards buying your first home – with a 25% bonus on your Lifetime ISA savings (up to £1,000 per year as your Lifetime ISA limit is £4,000 per tax year).

But you’ll need to be sure you want to buy a home, as you won’t be able to withdraw money after you start saving with your Lifetime ISA provider (well, you can, but you’ll have to pay a very hefty charge of 25% of the total, unless you have a terminal illness). Or, you can wait until you are 60 to withdraw, and use it to enjoy later life.

It’s a great way to build up a large amount of money for your house deposit in a relatively short period of time, whether you choose a Cash LISA or a Stocks & Shares LISA.

And as your savings grow inside your account, you’ll also pay nothing in tax too! So, if you’re saving for a few years or more, it could be worth saving in an expert-managed Stocks and Shares Lifetime ISA and benefit from potentially higher investment growth.

And don’t forget, you have to have your LISA open for 12 months before you can use it for your first home – so you better get opening one soon! You’ll be in your own home in no time. You can normally open one with a first payment of just £1 too.

You can also use a LISA to save for later in life, for when you’re over 60, but we recommend you don’t use it as an alternative to a pension, just as a little extra for when you retire. A private pension has far better benefits to help grow your money for retirement, and an equivalent to the 25% bonus too.

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This article was written by the team at Nuts About Money, and fact-checked by 2 independent reviewers. You’re in safe hands.

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