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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.

This product risks being underappreciated

Last week the Treasury Committee, a group of MPs tasked with holding the Exchequer to account, published a wide-ranging report on household finances.

The report’s recommendations have been widely picked up in the press, with the Lifetime ISA (LISA) – a product created in 2016 to help young people save for a first home or retirement – facing particularly harsh criticism.

The MPs criticise the LISA for being too complex and not complementing traditional pensions, and call for the product to be abolished.

I fundamentally disagree with this conclusion. To demonstrate my point, I will now provide a short, simple explanation of how the LISA works – and a few ways you could use it alongside your pension.

HOW IT WORKS

The LISA is only available to savers aged 18 – 39, so if you’re 40 or over you can’t apply. You can save up to £4,000 a year in a LISA and the Government will top it up by 25%.

Provided you open a LISA before your 40th birthday you can keep contributing – and receiving the 25% bonus – until your 50th birthday.

You can then withdraw the money tax-free to put towards your first home (provided it is worth £450,000 or less), if you’re aged 60 or over, or if you become terminally ill.

In all other circumstances the Government will levy a 25% charge on the money you take out – likely to be more than the Government bonus if your fund has enjoyed investment growth.

And that’s it.

SHOULD I GET ONE?

If you’re saving for a first home it’s a bit of a no brainer – the only thing you’ll need to consider is your investment time horizon and the level of risk you want to take.

If you’re using a LISA for retirement, it should be in addition to your workplace pension – which comes with a matched contribution as well as a tax relief bonus – rather than instead of.

Which is more appropriate then comes down to your individual circumstances. The automatic bonus on pension contributions is 25% if you’re a basic-rate taxpayer, meaning an £80 contribution becomes £100 without you having to do anything.

Higher-rate taxpayers can then claim back a further £20 and additional-rate taxpayers £25 through their tax return. If you fall into either of these brackets, it’s likely a pension will be a better deal than a LISA for your retirement.

However, for basic-rate taxpayers the combination of 25% bonus and tax-free withdrawal at 60 is compelling.

It could also be a viable retirement savings alternative for wealthier investors who are pushing up against the £1m pensions lifetime allowance, as well as self-employed workers who don’t benefit from a matched employer contribution.

Tom Selby, senior analyst, AJ Bell

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