Is the Lifetime ISA fit for purpose?

The Lifetime individual savings account (LISA) has attracted more than its fair share of controversy since the product launched in 2017.

Just a year into its existence, MPs on the Treasury Select Committee called for its abolition, citing too much complexity and a lack of popularity.

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Several years on and the concerns about consumer uptake have somewhat faded. The number of LISA accounts taken out has surged past one million, with total investments topping £4 billion.

These volumes may be dwarfed by the two most popular ISA types – Cash and Stocks and Shares – but are still significant.

It’s easy to see why savers are drawn to the LISA. Provided you’re aged between 18 and 39, you can pay in up to £4,000 a-year until age 50 to buy a first home or fund your retirement and receive a generous 25% bonus on anything you pay in.

In terms of investment options, there are two versions: Cash and Stocks and Shares. You can use one, the other, or both but must not exceed the £4,000 a year maximum subscription limit. What’s more, like with all ISAs, any growth and income escape the taxman’s grasp.

For anyone within the age criteria who doesn’t own a home but aspires to, it’s a no-brainer, surely?

And the LISA indeed works wonders for some savers. But scratch beneath the tax wrapper’s surface and a couple of cracks appear. 

First, if for any reason you need to access your LISA savings before either of the allowable events, you face an early withdrawal penalty, which is heavier than any bonus received. New research, which I cover below, shows that increasing numbers of savers are succumbing to this charge.

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Second, a maximum property value is imposed, and this has remained static for seven years, despite house prices climbing more than 25% over this period.

So, this raises two key questions: is the LISA still fit for purpose? And if it isn’t, what needs to change?

LISA early withdrawal penalties on the rise

A recent freedom of information request submitted by MPowered Mortgages to HMRC unearthed some concerning trends regarding LISA penalties.

The request found that just 12% of LISA savers have successfully used their account to buy a home, while 185,000 have collectively been fined £127 million for making unauthorised withdrawals. The average penalty was £684, including lost interest.

Source: MPowered Mortgages/HMRC.

These might not be huge numbers in the grand scheme of things, but the direction of travel is worrying. While the average withdrawal charge has crept lower over the past couple of years, both the volume and proportion of accounts paying it has risen sharply.

In the absence of reform, we can expect the number of savers getting caught out will continue to rise over the coming years.

The data here points towards several problems. Chief among them is that, if only a small percentage of savers are using a LISA to buy a home, is it really functioning as it should?

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One thing we must take into account is the product’s shortish lifespan. Even if you used the full LISA allowance every year since inception, the accumulated fund may still be inadequate for a deposit in some parts of the country, notably London and the South East.

As such, those planning to use their LISA to buy a property might still be yet to act – perhaps struggling to afford the required mortgage due to 16-year high interest rates, or holding off in the hope that house prices will fall further.

There is, however, a growing issue within the eligibility criteria that could be preventing savers from using their LISA for the purpose they intended.

The LISAs shortcomings

One key aspect is that LISA savings can only be used to buy a property that costs £450,000 or less - a huge bone of contention as I explain further down.

Other terms include that you must wait at least 12 months after you make your first LISA payment, use a conveyancer or solicitor to act for you in the purchase, and buy with a mortgage.

However, if you don’t use the money to buy your first home, are terminally ill with less than 12 months to live, and access it before age 60, you’re slapped with a withdrawal charge of 25%. As this is levied on the total value of your LISA, the equivalent charge is 31.25%, which more than wipes out any annual bonus pocketed.

Put simply, you’d be left in a worse position than if you had taken out a standard ISA.

How can the new government solve these problems?

The new government has pledged to help younger people get a foot on the property ladder. Its manifesto included a mortgage guarantee to support those who struggle to save for a big deposit.

Time is of the essence here as the task of buying a first home has become steeper over time.

According to Nationwide’s house price index, a home valued at £450,000 in Q2 2017 is now worth £567,962 – a 26.2% jump.

Yet the LISA’s maximum property cap has remained static since launch – a potential obstacle for some LISA savers.

Budding homeowners whose dream first property exceeds this amount must either choose a cheaper property, suffer the LISA withdrawal charges, or leave the money tied up till age 60.

On an encouraging note, Helen West, former Labour MP for Hornsey and Wood Green, wrote to the Tory government in 2022 to express her concern about the cap, and called for an immediate uplift.

West said: “My constituents, like so many across the country, have spent the last five years meticulously saving in order to purchase their home and it is unacceptable that the government’s own calculations have failed to keep up with the soaring costs of properties and inflation. This is not good enough and the scheme is failing to keep up with its promises.”

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Some LISA savers, particularly those looking to buy in expensive areas, will hope Keir Starmer’s newly formed Cabinet shares West’s gripes. However, raising the maximum property value is not the only upgrade people are campaigning for.

In the lead-up to this year’s Spring Budget, rumours swirled that then-Chancellor Jeremy Hunt was poised to reduce the early withdrawal charge from 25% to 20%, so that it reversed the upfront bonus, but didn’t penalise savers further.

But not only did the LISA fail to make the former chancellor’s package of reforms, but any help for budding homeowners was also strikingly absent.

Now that the government has changed hands, responsibility rests with the Labour Party to work out what must change to support aspiring homeowners.

While there was no specific mention of the LISA in Starmer’s manifesto, earlier this year the party said that, if elected, it will seek to “simplify the ISA landscape to make it as easy as possible for people to feel the benefits of saving and investing their money”.

Somewhere within its ISA review and first-time buyer promises, one would hope ministers look under the LISA’s bonnet and put the necessary improvements into place. But unless this happens sharpish, more and more LISA savers could see their home-buying dreams impacted or perhaps even derailed by the product’s inadequacies.