Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Why using a Cash Lifetime ISA for retirement could be a costly mistake
Shares’ in-depth feature on 3 May focused on the Lifetime ISA, and specifically what investors should do when a juicy bonus of up to £1,000 lands in their account.
The article rightly suggests for those with a short investment time horizon (primarily people planning to use their Lifetime ISA for a first home purchase) that a cash-based Lifetime ISA, such as that offered by Skipton Building Society, would probably be the most appropriate choice.
Equally, anyone using a Lifetime ISA for retirement – which could be decades away – probably shouldn’t be putting their money in a cash-based Lifetime ISA paying 0.75% (the current rate offered by Skipton).
In light of this I was concerned to read an article in The Telegraph suggesting almost a third (28%) of Skipton’s Lifetime ISA customers are using the product entirely or in part for retirement.
If you are doing this, or thinking of doing this, you risk making a costly mistake.
While clearly markets can go down as well as up, history tells us patient investors can reap the rewards of investing in stocks and shares over a longer period of time.
Furthermore, with inflation hovering somewhere between 2% and 3%, a product paying 0.75% is failing to protect the spending power of your hard-earned savings. But how much difference could this make over the long-term?
If a 26-year old saved the maximum £4,000 a year (and so receiving a bonus of £1,000 each year) in a Lifetime ISA until age 50 in an account paying 0.75%, they would end up with a pot worth £149,000 at age 60.
If the same person saved the money in a stocks and shares Lifetime ISA returning exactly 4% a year after charges, they would build up a retirement fund worth £321,000.
While there is no guarantee you will achieve these investment returns and Skipton’s rates could creep upwards when the Bank of England eventually raises the base rate, it does illustrates the extra investment bang you could get for your Lifetime ISA buck by investing in the markets.
It’s also worth noting that a workplace pension, where you get an employer match on your first 2% of contributions, should be the retirement starting point for most people.
If you’re a higher or additional-rate taxpayer, a pension pays a higher bonus through tax relief than a Lifetime ISA, although only 25% of your pension withdrawal is tax-free at age 55 (with the rest taxed at your marginal rate). In contrast, your entire Lifetime ISA fund can be withdrawn without paying any tax from age 60. For basic-rate taxpayers the bonus in pensions and Lifetime ISAs is the same.
While there are some tricky calculations to be made here, it’s worth taking the time to consider them so you don’t sell yourself short in the long-term.
Tom Selby, senior analyst, AJ Bell