The Treasury’s proposed replacement for the Lifetime ISA (LISA) could leave first-time buyers with smaller mortgage deposits, it has been warned.
A consultation on a revamped LISA product closed on 18 August.
The proposed new product addresses major criticisms of the LISA by removing the upper age limit and scrapping “unauthorised” withdrawal charges.
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But there are concerns that other changes including a shift to paying the government bonus once the money is needed rather than annually could be bad for first-time buyers.
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Research by savings provider Moneybox suggests that based on saving £333 a month and a 6% annual return in a stocks and shares LISA, an investor would lose out on £3,606 in compound growth with the new product.
How would the First Time Buyer ISA work?
The new First Time Buyer ISA (FTB ISA) is designed solely for the purposes of buying a first home.
Self-employed workers who can't access auto-enrolment would need to stick with a LISA or focus on a private pension or self-invested personal pension to save for retirement.
Similar to the LISA, there would be cash and stocks and shares options, money saved into the account would go towards your annual ISA allowance and there would be a government bonus, although the level hasn't been announced.
Accounts can only be open from age 18 and there would be no upper age limit.
Subscription limits, property price caps and the level of the government bonus will be announced at a future fiscal event to take account of market conditions and wider public finance context, the Treasury said.
The document added: “Increases to any of these parameters in isolation would come with a cost. A lower subscription limit and/or property price cap could allow for a higher government bonus and would shift the benefits towards lower income savers outside London and the South East.”
There isn't a launch date yet for the product but the Treasury said it would like it to be available "as soon as practically possible".
What is the difference between the First Time Buyer ISA and the Lifetime ISA?
There are a few differences between the FTB ISA and the LISA, including it only being available to first-time buyers.
Unlike the LISA, which has to be opened by age 40 and the bonus can only be earned until age 50, there would be no upper age limit.
The government bonus would be paid as a percentage of subscriptions made, rather than the value of the account, at the point that an individual withdraws funds to purchase their first home.
This means that the bonus is calculated on what an individual has put into the account, minus any withdrawals made, not on any investment growth or savings interest accrued subsequently.
Under the current system, providers pay the government bonus in a LISA each month, when a contribution has been made in the previous month. For example, if you deposit £1,000 in one month, a 25% bonus (£250) would be added in the following month.
But the new FTB ISA bonus would be paid at the point an individual makes a withdrawal for purchasing their first home.
The Treasury said this removes the need for a withdrawal charge and means a saver can withdraw funds, should their circumstances change, without penalty.
Rachael Griffin, tax and financial planning expert at Quilter, said: “Thousands of savers have been charged for accessing their LISA for an unauthorised withdrawal, often because their financial circumstances changed unexpectedly and they needed to dip into their savings. Allowing people to access their money when needed, while still being incentivised to save towards a deposit for a first home, would be a much better design.
“Equally important is the decision to remove the upper age limit. The average age of a first-time buyer has been consistently on the rise, yet the Lifetime ISA effectively shut the door on those who did not get onto the property ladder prior to turning 40. A reformed product with no age limit would reflect a more modern housing market.”
Rachel Vahey, head of public policy at AJ Bell, said moving away from an upfront bonus should make the system simpler but she has warned that savers would lose out on the investment growth they could have earned on the bonus while building up their deposit.
She highlighted that someone paying in £4,000 each year for five years into a stocks and shares Lifetime ISA with a bonus added each year would have built up £28,165 assuming 4% growth net of charges. Under the FTB ISA, assuming the same terms including payments, and that a government bonus of 25% is added when buying the house, the ISA holder would only have built up £27,532.
Vahey added: “For some first-time buyers, that could mean having less money available when they come to purchase a home.”
Who can use the FTB ISA?
The FTB ISA would be available to UK residents over age 18 looking to purchase their first home.
It can only be used with a mortgage, which excludes cash buyers and you would need to have the account open for at least 12 months to become eligible for the bonus.
What will happen to the Lifetime ISA?
There is no suggestion currently that the LISA will be phased out so accounts can still be opened and used.
Individuals with funds in a LISA would not be able to transfer their money to the new FTB product as they would have already received the government bonus.
But you would be able to use any funds in your existing LISA and those in the new FTB ISA for the same purchase.
Individuals would be able to hold both the new FTB ISA and an existing LISA, but would only be able to save into one in the same tax year.
Regardless of where the property price cap is set, the FTB ISA, LISA and Help to Buy ISA cap would be aligned so no account holders would lose out, the Treasury said.
To ensure that holders of the Help to Buy ISA do not lose out, the Treasury is also proposing that holders would be able to transfer their holdings into the new FTB product up to the subscription limits.
Additionally, as part of wider ISA reforms, transfers from a stocks and shares ISA to the new cash FTB ISA would be banned.
Rather than introducing a whole new product, Moneybox suggests the Treasury should reform the Lifetime ISA to ensure it keeps working for everyone.
Brian Byrnes, director of personal finance at Moneybox,said: "The terms being considered for the new replacement product risk widening this deposit gap further.
“Withholding the bonus until completion takes over £3,600 in compound growth away from a dedicated 10-year saver, while banning transfers to cash before exchange leaves deposits unnecessarily exposed to market volatility.
“Committing to an annual review of the house price cap and reducing the [LISA] withdrawal penalty to 20% means savers will never lose any of their hard-earned money – giving future homeowners the certainty and support they urgently need."
AJ Bell chief product officer Charlie Musson added that there is zero evidence replacing the LISA with a First Time Buyer ISA will benefit consumers.
He said: "The smoke and mirrors approach is designed to appear to support savers, with a focus on first-time buyers. The truth is it will likely dilute the government support on offer, returning to a product similar to the now defunct Help to Buy ISA.
“If government were serious about offering more help for first-time buyers it would instead look at some of the flaws in the existing Lifetime ISA and get on with fixing them. Instead, like a shady plumber, government is trying to sell an unnecessary refit instead of fixing the obvious leak.
“To make matters worse, savers already using Lifetime ISAs will be collateral damage, left stranded in a legacy product unless government takes steps to allow them to move. As an absolute minimum government should permit people to switch to either a pension or an alternative ISA product, avoiding the creation of yet another legacy savings product in the UK.”
