Choose your ISA carefully

Former Chancellor George Osborne’s Lifetime ISA looks set to become part of the long-term savings landscape after the Government belatedly published draft legislation setting out how the product will work.

Investors can now be fairly confident the new vehicle will launch as planned in April next year. It also seems the Lifetime ISA, at least initially, will be broadly similar in design to that announced in what turned out to be George Osborne’s final Budget as Chancellor of the Exchequer in March.

That means if you set up your Lifetime ISA on or before your 40th birthday you’ll be able to pay in up to £4,000 a year into the Lifetime ISA and receive a Government bonus of 25%, up to a maximum of £1,000. 

You’ll only be able to keep paying in until your 50th birthday. So if you want to save after this you might need to consider setting up a stocks and shares ISA or pension if you don’t have one already.

If you have a Help to Buy ISA you will be able transfer those savings into the Lifetime ISA and receive the government bonus in 2017/18, but if you transfer after this you won’t get the bonus.  You can also continue saving into both for more than ten years and you’ll need to bear in mind that if you want to use both to buy a house, you’ll only be able to use the bonus from one or the other.    

Withdrawals will be penalty-free in only very limited circumstances – namely if you’re using the money on your first home (provided it is worth £450,000 or less), you fall into ill health, or you take out money from your pot from the age of 60. You’ll also need to have been saving for at least a year to avoid being hit with exit charges.

The Government had been considering expanding the circumstances for penalty-free withdrawals and potentially even allowing you to borrow from your fund, but neither is allowed for in the draft legislation.

The penalty for all other early withdrawals is severe – and we have crunched the numbers to give you an idea of just how much you could lose. While the Government described the exit charge as small, when combined with the return of the Government’s bonus it amounts to 25% of whatever money you take out.

So, if you contribute the maximum £4,000 over 10 years you would have invested £40,000 and this would have been topped up with £10,000 of Government bonuses to give a total investment of £50,000.

If this grows at 4% per annum after charges (the total return of the FTSE All Share index over the past 10 years was 5.8%) the fund will be worth £62,432. But you then decide you need the money for something else and take it out before age 60.

The 25% exit charge on £62,432 is a whacking £15,608.  This returns the Government contributions of £10,000 plus £5,608, which equates to 45% of all investment growth generated over the period.

That is not, of course, to say the Lifetime ISA is not worth considering. For first time buyers saving for their first property it is a good deal. Whilst basic rate taxpayers could find it attractive as a retirement savings vehicle (the bonus is equal to the tax relief you get from a pension and withdrawals are tax-free from age 60).

However, if you are a higher rate taxpayer you just need to be absolutely sure that you won’t need the money for any other reason because the penalties – no matter what the Government might claim – are severe.

Investors should also consider whether a stocks and shares ISA or cash ISA wouldn’t be a better fit for their investment needs. Our lifetime ISA, stocks and shares ISA and SIPP comparison can also help you choose the right account and you can register to receive updates on the lifetime ISA from us.