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Why investing in the markets through the tax efficient vehicle is likely to deliver better returns
Thursday 29 Jul 2021 Author: Laith Khalaf

The Lifetime ISA has proved to be a bit of a hit with savers and investors, confounding the many sceptics who disparaged the account when it was first launched. Latest figures from HMRC show that 545,000 people subscribed to a Lifetime ISA in the 2019/20 tax year, up from 223,000 in the previous year.

But a recent survey conducted by AJ Bell suggests that some savers aren’t allocating their money as effectively as possible.


The Lifetime ISA was introduced in 2017, with the dual aim of helping younger people save for a house deposit, and to also encourage retirement saving. Anyone between the ages of 18 and 40 can open a Lifetime ISA, and once open, you can continue to top up the account until your 50th birthday.

As with a standard ISA, gains and income are free from tax, but the extra sweetener is the government adds tax relief to boost each £100 you put in by a further £25. So if you put in the maximum £4,000 allowed each tax year, the government will add £1,000 to your Lifetime ISA pot. The only price for this largesse from the Treasury is that you can only withdraw funds to buy your first house, or from your 60th birthday onwards. Other withdrawals attract a penalty which recoups the tax relief, and a bit extra to boot.


The AJ Bell survey found that 45% of Lifetime ISA holders were using the account to save for a house deposit, while 33% were saving for retirement. But of those saving for retirement, 60% said they had opted for a Cash Lifetime ISA.

This is pretty astonishing, because Lifetime ISA savers are in their 20s, 30s and early 40s. Indeed the average age of our survey respondents was 36. While using a Cash Lifetime ISA to save for a house deposit makes some sense, as you may need the money back in relatively short order, those saving for retirement are decades away from drawing on their money.

Holding cash over such a long period opens them up to the threat of inflation eating away at their savings, while also missing out on the longer term returns expected from stock market investment.


The Lifetime ISA is actually a pretty good way for basic rate taxpayers to save for retirement, but those who opt for cash will likely end up with much smaller pots than those who invest in shares.

Clearly we don’t know precisely what returns are going to look like over the next 20 or 30 years, but the Barclays Equity Gilt Study shows that since 1899, UK shares have returned 5% above inflation, and cash just 0.7% above inflation. Based on these figures, a 30 year old paying the maximum £4,000 in each year (plus £1,000 tax relief) until age 50, would have a pot worth £174,706 at age 60 if held in cash, or a pot worth £404,874 if invested in stocks (assuming 2% inflation and 0.3% in annual investment charges for an index tracker fund).

Worse still, cash rates are currently much lower than historical averages. The same Barclays Equity Gilt study shows that if we look over the last 10 years, UK shares have returned 4.9% above inflation, and cash has returned 2.5% below inflation, so the latter has lost a significant chunk of its buying power. Right now, inflation is on the rise, but cash rates don’t look like they’re going anywhere. So it’s a particularly inauspicious time to be holding cash for long term savings purposes.


Broadly speaking, lots of consumers do seem unwilling to move out of cash, even for long term savings. Indeed this prompted the FCA (Financial Conduct Authority) to conclude, in a report issued last December, that many consumers are missing out on making their money work better for them in the long term by holding cash rather than investing.

One of the outcomes of the FCA’s business plan for the next year is actually to see fewer people with an appetite for risk holding high levels of cash, because it’s potentially damaging to their ultimate wealth. Lifetime ISA holders who are saving for retirement have taken a big step in the right direction. But those who have so far plumped for cash should give serious thought to switching across into stocks. Their future selves will probably thank them heartily.

DISCLAIMER: Financial services company AJ Bell owns Shares magazine. Tom Sieber who edited this article owns shares in AJ Bell.

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