Should I save for a home in a Lifetime Isa and what are the penalties?

Anyone wanting to save a deposit to buy their first home should consider putting money into a Lifetime Isa – and earn a 25 per cent bonus on contributions.

Laura Suter, head of personal finance at wealth manager AJ Bell, says: ‘The main reason for taking out a Lifetime Isa is to get on the property ladder. 

‘You can choose to put money into stocks and shares or cash. But if you are planning to save for at least five years then stocks and shares are a much better option if you want your plan to grow in value.’ 

Alternatively, the Isa can be used to save for later life, as the cash can also be taken out at the age of 60, but if it is taken out before then for anything other than a first home purchase then a hefty 25 per cent penalty applies.

Boost: Savers under the age of 40 can open a Lifetime Isa and get a 25% government bonus.

How a Lifetime Isa works

Savers under the age of 40 can open a Lifetime Isa (Lisa) and until they hit 50, the Government will chip in £1 for every £4 they save, giving a £1,000 bonus on the maximum £4,000 a year you can save. 

That money can either be used towards a deposit on a first home or be withdrawn from the age of 60 to help fund retirement.

But be aware that you may end up worse off if you cash in the Isa before 60 without buying a first home. This is because a 25 per cent penalty applies to the amount withdrawn in this case.  

Two people buying together can each use their Isa as a deposit. But whether buying individually or as a couple the value of the property must not exceed £450,000. 

It’s also worth noting that those with a Help to Buy Isa can transfer those savings into a Lifetime Isa. 

The Help to Buy Isa was closed to new savers in November 2019, but those who already have them can still pay in until 2029. However, you can only use the bonus from one to buy a house.

How the Lifetime Isa bonus works

The great advantage of a Lifetime Isa is the 25 per cent uplift on money paid in. This is similar to basic rate tax relief on a pension and means that it gets savers back to the point they were at before 20 per cent tax was applied.

For those using a Lifetime Isa for retirement this means there is little advantage over a pension, but if someone is saving or investing for a deposit for their first home then that added 25 per cent on contributions of up to £4,000 per year really pays off.   

HMRC now calculates bonus payments on a month-by-month basis, so this means any bonus is calculated based on payments you make into your account from the 6th of each month to the 5th of the following month. 

When you receive your bonus after that will slightly depend on your Lisa provider, but typically you should see the bonus enter your account between four and ten weeks after making your contribution.  

Follow the rules when buying 

When using the Lifetime Isa to buy a home it is crucial that you are aware of the restrictions that might render the bonus void.

You must be a first-time buyer to be able to use the Lifetime Isa towards a property purchase. You can also buy with another first time buyer and both use a Lisa and its bonus.

You can also use it to buy with someone who isn’t a first time buyer, although they obviously can’t use their own Lifetime Isa if they were to have one. 

This means you cannot have previously owned a property in the UK or anywhere else in the UK. It’s worth noting that the property you purchase must also be in the UK.

You also must be buying a home you plan to live in. The scheme isn’t for those purchasing a buy-to-let or holiday home.

You will have to use a typical repayment mortgage where you will pay back a part of the loan, as well as the interest, each month until you eventually pay off the mortgage.

You can’t, for example, use an interest-only mortgage, where you only pay the interest each month, with the loan amount remaining the same. 

Finally your Lifetime Isa cannot be used for any home purchase made within 12 months of the it being opened.

How the money is used for a house deposit

When you eventually buy a property don’t just withdraw the funds, as that will result in the penalty charges.

Instead you need to apply to your Lifetime Isa provider for the money to be sent to your solicitor handling your purchase. 

The money can be used towards the deposit when you exchange contracts prior to completion, although there cannot longer than a 90 day delay. 

If the sale falls through your solicitor will be able to put the money and bonus back into your Lifetime Isa – though it must be the same amount. 

How the Lifetime Isa penalty works 

The thing to watch out for on the Lifetime Isa is that money that doesn’t qualify as a deposit for a first home is heavily penalised if withdrawn before the age of 60.

So if you paid in £1,000 and received the £250 Government bonus, you would have accumulated £1,250, assuming no investment growth. 

But if you then withdrew the money without using it for a suitable home deposit the 25 per cent penalty would apply to the £1,250, leaving you with £937.50 – and £62.50 out of pocket. 

Whilst keeping a Cash Lisa will ensure you don’t technically lose money, rock bottom savings rates and soaring inflation will mean the purchasing power of your Lisa may fall in real terms.  

Should you save or invest with a Lifetime Isa?

General investment advice has always been that investing is best if you don’t plan to use the money for at least five years. For anyone with a shorter timeframe, cash will be deemed the safe option.

However, given the rock bottom savings rates, soaring inflation and the buffer of the 25 per cent government top-up, there may be an extra temptation for Lifetime Isa holders to invest  – albeit within reason.

After all, given the Lifetime Isa bonus, your investments would have to fall by more than 25 per cent for you to be down on what you have paid in.

Tom Selby, head of retirement policy at AJ Bell, said: ‘The current environment of rising inflation and low interest rates mean that sticking to cash is guaranteeing a loss in real terms, as no cash account is paying an interest rate to match inflation. 

‘That means that some savers might decide it’s worth the risk of investing in the market, in the hope of generating inflation-beating returns to boost their house deposit. 

‘There’s no right answer, it just comes down to the individual’s attitude to risk, time horizon and type of investments they plan to make.’ 

Who offers Lifetime Isas? 

None of the big banks offer cash Lifetime Isas. In fact, only a handful of providers do.

This dearth of products could pose problems for young homebuyers wanting a cash Lifetime Isa for a relatively short period, since the usual rule of thumb is to avoid investment risk if you will definitely need all the money within the next five years.

We round up the Lifetime Isas that are available below.

Cash Lifetime Isas

Skipton Building Society: Its cash Lifetime Isa can be opened with £1 and offers just 0.25 per cent annual interest. 

Nottingham Building Society: Its Beehive Lifetime Isa can be opened with £10 and  pays 0.8 per cent interest. 

Newcastle Building Society: A Lifetime Isa can be opened with £1 and Newcastle offers 0.5 per cent interest. 

Moneybox: The investing app has a cash Lifetime Isa that can be opened with £1. It pays 0.85 per cent but that drops to 0.25 per cent after a year 

Paragon Bank: The bank is offering a 0.5 per cent interest rate and the minimum deposit is £1.

Some stocks and shares Lifetime Isas 

Not all DIY investing platforms offer Lifetime Isas as well as their standard stocks and shares Isas – for example, Interactive Investor, Vanguard, Fidelity and Freetrade don’t, but there is a reasonable of options.

You can choose between a stocks and shares Lifetime Isa that lets you choose your own investments, or a service that does the work for you – in the middle lie the ready made portfolios some investment platforms offer.

Hargreaves Lansdown: The Lifetime Isa minimum lump sum investment is £100, or the minimum monthly payment required is £25.

Investors pay a annual fee of 0.45 per cent on investment funds held and fund fees too, but fund dealing is free. For shares, investment trusts and ETFs this charge is capped at £45 per year but buying and selling costs £11.95 per time.

You can either invest in any shares, funds or trusts you like, or opt for one of Hargreaves’ existing ready-made Isa portfolios, tailored for different investment needs. 

AJ Bell: The AJ Bell Youinvest Lifetime Isa offers access to all the broker’s funds, shares, investment trusts, ETFs, gilts and bonds, allowing investors to build their own portfolios. 

The annual charge is 0.25 per cent for funds. It is also 0.25 per cent for shares, although this is capped at £3.50 a month. 

You can either kick off with a minimum lump sum of £500, or just start putting away £25 a month under a regular investment plan. 

Buying and selling shares, investment trusts and ETFs costs £9.95 per time, whist funds only attract a £1.50 charge each time.

For those looking to use their Lisa towards buying their first home, the 25% bonus may give them a little more confidence to try investing.

Nutmeg: Its Lifetime Isa is available with a minimum lump sum requirement of £100.

Nutmeg customers are questioned about goals and risk appetite and can then be directed to the portfolio deemed to best match their needs.

The Lifetime isa has four investment options, ranging from the standard fixed allocation portfolios, with a 0.72 per cent annual charge, to Smart Alpha (1.04 per cent), Fully Managed (1.02 per cent) and Socially Responsible  (1.14 per cent) options. 

Moneybox: The mobile app aims its Lifetime Isa at those saving a deposit for their first home, rather than pitch it as a way to save for retirement. 

When you sign up, they offer you a choice of three risk-rated portfolios – cautious, balanced and adventurous. 

They give you exposure to cash, global equities, corporate bonds and global property equities through three passive funds.

Moneybox lets you start investing with just £1. It charges £1 a month to cover transaction fees and also has a platform fee of 0.45 per cent. 

Investors also pay fees for the tracker funds on top of this, which range from between 0.12 and 0.3 per cent each year.

This post first appeared on Dailymail.co.uk