The Lifetime ISA – how long will it take to save for a house purchase and does it work for retirement?

The new Lifetime ISA is due to launch on 6^th April 2017 – AJ Bell is aiming to launch its Lifetime ISA later in April.

AJ Bell analysis looks at how the product could work for:

• Saving for a house deposit

          - How long will it take

          - How savers can Turbo Boost their LISA

          - The sting in the tail – the exit penalty

• Saving for retirement

          - Auto-enrolment – best option if available

          - LISA – could be a good option for basic rate tax payers, but contributions are limited

          - SIPP – likely to be better for higher rate tax payers and contributions can be higher

Tom Selby, senior analyst at AJ Bell, looks at the main consideration for retail investors:

Saving for a house deposit

“For people saving specifically for a deposit on a first home, the Lifetime ISA is almost certainly going to be the best option.  The Government will add a 25% bonus to any contributions made up to £4,000 each year and all returns are tax free, making it a very attractive saving option for buying a home.

How long will it take?

“The average deposit for first time buyers is £32,321 according to the Halifax.  The time it takes to save that amount will depend on the amount invested and the investment return that can be generated.  Investors will need to decide whether they want to invest in cash or take more risk to try and shorten the period it takes to reach their target.”

Table 1 below shows how long it would take to save for a house deposit via a LISA based on saving the full amount each year and half the amount each year, both in a cash LISA paying 1% per year and in a stocks and shares LISA returning 5% per year.

Table 1:

Source: AJ Bell.  For illustrative purposes only, the actual return will depend on the performance of the investments selected which can go down as well as up.

How investors can Turbo Boost their LISA

Help to Buy ISA transfer

“The Help to Buy (H2B) ISA launched on 1 December 2015. You are allowed to put in £1,200 in the first month, then a max of £200 a month thereafter. So for someone who has maxed out, that’s £1,200 + (15 x £200) = £4,200.

“Transfers from a H2B ISA to a LISA do not contribute towards the annual LISA allowance and attract the same bonus. So investors could have up to £4,200 to transfer over, and then save £4,000 into their LISA in the first year.

“The amount saved is therefore £8,200 which would attract a bonus at end of the year of £2,050, resulting in £10,250 being invested in the LISA in year one and setting the investor well on the way to their house deposit.

“To take advantage of this additional bonus the transfer of the H2B ISA has to be made in the 2017/18 tax year.”

ISA transfer to LISA

“There’s also a neat piece of planning people can do by transferring ISA allowance from previous years into LISA.

“While any new money saved into a LISA will count towards the overall £20,000 yearly ISA allowance, money transferred across from previous years’ ISA subscriptions won’t.

“So an investor could shift up to £4,000 saved in ISAs in previous years into their LISA, receive the £1,000 Government bonus and still contribute up to £20,000 into their stocks & shares ISA in 2017/18.”

The sting in the tail – the exit penalty

“The LISA comes with a pretty large string attached – a 25% exit penalty.

“If someone contributes the maximum £4,000 over 10 years they will have invested £40,000 in total. This will have been topped up with £10,000 of Government bonuses to give a total investment of £50,000.

“Using the table above, if this grows at 5% per annum after charges the fund will be worth £65,956. If the investor takes that money out before age 60, is in good health and does not use it to purchase a house, the 25% exit charge would be a whacking £16,489. 

“This returns the Government contributions of £10,000 plus an additional £6,489 penalty, which equates to 40% of all investment growth generated over the period.”

Saving for retirement

Table 2 below shows the fund value that could be generated through a LISA, SIPP and auto-enrolment workplace pension.  It assumes a starting age of 25, an annual growth rate of 5%, an annual salary of £20,000 and an auto-enrolment rate of 3% employer, 4% personal, 1% Government contributions (the minimum levels required post April 2019).

Auto-enrolment – best option if available

“The best option for saving for retirement is nearly always going to be a workplace pension which most employed people will now have access to under auto-enrolment.  This will benefit from employer contributions as well as a Government top up in the form of tax relief and this has a significant impact on the value of fund at age 65.”

LISA – could be a good option for basic rate tax payers, but contributions are limited

“Those without access to a workplace pension or who want to save more on top of that need to decide whether to use a LISA or a SIPP.

“For basic rate tax payers, the Government LISA bonus of 25% is exactly equal to the Government basic rate tax relief of 20%.  Confusingly the numbers are different because of the mechanics of how they work.  The LISA bonus is 25% of how much the individual invests whereas the pension tax relief is 20% of the total amount invested. 

“The end result is the same, with both the LISA and SIPP producing a fund value of £126,840 in the example below.

“The advantage of the LISA is that there would be no tax to pay on this amount, whereas income tax may be payable on the pension payments depending on the individual’s circumstances. 

“So, for basic rate tax payers, a LISA could be a good option although they can only contribute up to £4,000 of savings each year.”

SIPP – likely to be better for higher rate tax payers and contributions can be higher

“Higher or additional tax payers can claim back an additional 20% or 25% of tax relief on their pension contributions via their tax return, so for them a SIPP is likely to produce a better outcome than a LISA.

“In the example below, total contributions would be £32,000 so an additional 20% tax relief would be worth £8,000 which could have been invested and benefited from compound investment growth over the period.” 

Table 2: