A few months ago, I was grabbing a quick lunch with one of the analysts on my team. His name was George and he is arguably one of the top performers I’ve come across in my career.
As we stood in line to pay for our Pret sandwiches, George was trying to milk me for intel on the upcoming analyst bonuses.
Of course, predicting investment banking pay is a bit like trying to beat the market with active investing. You can try all you want yet you will fail and walk away disappointed.
Therefore, our conversation quickly turned to what George was going to do with the money, whatever it turned out to be.
As he rattled off a few possibilities (I distinctly remember yacht week being mentioned), I interrupted him with a more practical idea and suggested he puts £4k in the Lifetime ISA.
What followed was an eye-opening discussion for both of us.
It was eye-opening for George because as it turns out, he had no idea what a Lifetime ISA was.
And it was eye-opening for me simply because I was dumbfounded that a finance professional would be ignorant about one of the best wealth building vehicles of all time.
Once back in the office, I did the rounds with the other junior bankers on my team. The statistics were dismal – just two of the nine knew what a Lifetime ISA was.
So if you are one of those people who haven’t yet heard of a Lifetime ISA – or doesn’t understand how it works, please read on. I promise it will be worth your while.
What Is A Lifetime ISA?
A Lifetime ISA is a government scheme designed to encourage people to save for their first home or retirement.
In some ways, it is very similar to a regular ISA. You can use it to invest in both cash and shares. Any interest income and capital growth on investments held in your Lifetime ISA are free of tax.
When you withdraw the money, it’s also 100% tax-free.
However, unlike a regular ISA, the Lifetime ISA has some very distinct features and advantages.
You Get A 25% Bonus On Your Contributions…
That’s right. The government will top up whatever contributions you make to the tune of 25%. The bonus is typically credited to your account in four to nine weeks after your contribution.
The maximum annual contribution you can make is £4,000 which means you can get up to £1,000/year in free money.
Do remember that your total ISA contribution remains at £20k. So if you’ve contributed £4k to your Lifetime ISA, you only have $16k of contribution room left in your ISA for that tax year.
…But There Is An Age Limit
Given the massive intergenerational feud going on at the moment, its no surprise that the Lifetime ISA was designed with younger savers in mind.
You can only open it if you are over 18 and under 40. However, once you’ve opened it, you can keep contributing (and getting the bonus) until you turn 50.
In other words, if you are about to turn 40, you need to open a Lifetime ISA NOW.
Even if you only contribute £1, it helps keep your options open for the next ten years.
You Can Get Up To £33k In Free Money…
That’s right. If you open a Lifetime ISA when you turn 18 and contribute the maximum £4k every year, the government bonuses will add up to £33k over the years.
…But You Can Only Withdraw When You Buy Your First Home Or Turn 60
As with anything that has to do with the government, there is a catch.
The money in your Lifetime ISA is earmarked to help you do one of two things:
- Buy your first home. It has to cost £450k or less and your Lifetime ISA needs to have been open for at least a year for you to use it
- Fund your retirement. You can withdraw the money in your Lifetime ISA as soon as you turn 60. Once you do, there are no restrictions on the timing and amount of withdrawals
Remember that the two options above aren’t mutually exclusive.
You can use the money in your Lifetime ISA to buy your first home, then continue using the account to save for retirement.
And What If I Don’t?
You are welcome to use the money in your Lifetime ISA for other purposes but you will need to pay a penalty of 25% on the amounts you withdraw.
This is designed to be punitive. If you put in £4k, get a £1k bonus and then withdraw your money, you will be left with £3,750.
That’s a 6.25% penalty on your original £4k investment.
But I’m Not A First Time Home Buyer
First of all, congrats on owning a home! Secondly, unless you expect to come into a major windfall when you turn 60, contributing to a Lifetime ISA could still make a lot of sense due to the 25% bonus.
This is subject to some caveats.
Unless you are a self-employed taxpayer in the basic (20%) tax bracket, contributing to a pension will always be more advantageous than a Lifetime ISA.
See below is an illustration of how workplace pension contributions lift your net worth.
As you can see, as a basic rate taxpayer, you already get a 25% uplift from the government on your workplace pension contribution (i.e. you contribute £80 and get £20 in the form of a tax break).
Your employer will then match your contributions to the tune of another £60. This means your £80 contribution has doubled to £160.
Even though your workplace pension is subject to some tax on withdrawal, the 100% boost to your contribution far outweighs the 25% bonus on the Lifetime ISA.
However, if you are a self-employed basic rate taxpayer contributing to a SIPP (i.e. you don’t benefit from employer matching), you are better off contributing to the Lifetime ISA.
This is because withdrawals from the LISA are 100% tax-free.
Here’s a handy guide that lays out the SIPP vs LISA differences.
Anything Else I Need To Know?
Yes. If you have a long-term investment horizon and decided that the Lifetime ISA is right for you, focus on using it to invest into a low-cost stock market index tracker.
After all, if you have the benefit of time it’s nearly impossible to beat passive stock market investments made through tax-efficient vehicles.
Got this far? You are now well-prepared to take advantage of one of the most powerful wealth-building tools available in the UK.
Readers, do you have any other Lifetime ISA questions not covered above? Feel free to leave a comment below to get an answer.
About Banker On Fire
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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
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