If you’ve given retirement some thought, you’ve likely begun paying into a pension and you may have a Stocks & Shares ISA.

Both of the above have their advantages in helping you build a decent nest egg to enjoy in later life, however one product not to overlook is the Lifetime ISA. This article will help you understand the benefits of using the Lifetime ISA.

What is the Lifetime ISA?

The Lifetime ISA (LISA) was introduced in 2017 and it was a replacement to the Help to Buy ISA, which many have used to assist them purchasing their first home. It is also an extremely useful tool in building an additional pot of money to fund retirement.

How does it work?

In short, you can save up to £4,000 in each tax year and in return the government will give you a 25% bonus. This means a £4,000 contribution will be worth £5,000 at the end of the tax year. Essentially free money! But there are some caveats…

The Lifetime ISA has two primary uses:

  • To use as a deposit on your first home, valued up to £450,000 and you cannot be purchasing the home as a Buy to Let (BTL)
  • As a retirement fund – You can have a cash Lifetime ISA or you can invest into Stocks & Shares (We wouldn’t suggest you invest your Lifetime ISA money if your property purchase is likely to proceed in the short term)

If you want to withdraw money from your Lifetime ISA for any reason other than the above, then you’ll need to pay penalties.

We’ll do a more chapter and verse guide in future blogs. If you want to get into the nitty gritty then the Lifetime ISA – GOV.UK (www.gov.uk) will help explain some of the minutia.

Using a Lifetime ISA to purchase your first property

If you are on the hunt for a property and are a first-time buyer under 40, then considering a Lifetime ISA could make a massive difference to your deposit amount. You need to have held a Lifetime ISA for 12 months before you can use it but assuming you have, lets use the following example.

You are purchasing your first home with a partner, who has also never purchased a property before. You contribute £4,000 now (November 2022) and they do too. You have both contributed £4,000 each, a total of £8,000. After government bonus’ you’ll now have £10,000 to go towards a deposit. Do this again in April 2023 (The next tax year) and you’ll have £20,000 saved, with £4,000 of that being free money from the Government.  

When you should open a Lifetime ISA

You can only open a Lifetime ISA before you are age 40, many people miss out and leave it too late. Once it is open though, you can contribute up to age 50. The majority use it to purchase a property, so often don’t realise how valuable it can be for retirement planning.

Compared to a pension

Lets say you are earning £70,000 per annum, any pension contributions you make attract tax relief of 40%. If you are a basic rate tax payer in retirement you receive 25% of your pot tax free and pay 20% tax on the 75%, a net rate of 15%. So you’ve made a 25% instantaneous tax saving.

However, if you are earning enough to have your annual allowance tapered, then you will be limited to contributing £4,000 per annum into a pension. So you’ll only get tax relief of 45% on £4,000 of contributions. Quite a measly amount considering your earnings and if you want a retirement lifestyle like you enjoy now, you’ll want to be putting more than £4,000 away each year.

The benefits of using the Lifetime ISA in retirement

There are a whole host of options available to you, but for the purposes of this article we’ll consider how the Lifetime ISA would be beneficial in retirement planning. 

If you contributed £4,000 to a Lifetime ISA, you’ll receive £1,000 tax free from the government and when you withdraw it after age 60 you won’t pay a penny in tax. So you’ll have a guaranteed 25% return! If you invest the money then the effect of compounding over 20 years could mean that £1,000 bonus is even more valuable.

My allowance isn’t tapered so why should I do this now?

Many of us don’t reach peak earning potential until after 40, and so by the time a tapered annual allowance issue is reached it’s too late to open a Lifetime ISA. We would suggest opening a Lifetime ISA, even with a modest amount before you reach age 40, so that if you do reach the taper you’ll have the option to contribute in future years.

Frequently Asked Questions 

  • Does this form part of my ISA allowance? Yes if you contribute £4,000 into your Lifetime ISA, you can only contribute a further £16,000 into a Cash or Stocks & Shares ISA in that tax year.
  • Does the bonus use some of my ISA allowance up? No it does not.
  • Should I invest my Lifetime ISA? If you are not buying a property, you won’t be able to access the Lifetime ISA without penalty until age 60, so it’s likely to be a good idea to consider this

So there you have it, the benefits of using the Lifetime ISA, it can all get a bit confusing so if you would like to discuss any of the above with a local independent financial adviser  in Rayleigh, then please get in touch.

Not local? We’re always happy to meet via video conferencing.

T: 01268 944122

E: p.denning@sterlingandlaw.com

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