Is a Lifetime ISA worth it? How LISAs work and key rules

If you’re looking to get onto the housing ladder but are struggling to stitch together a mortgage deposit, a Lifetime ISA (LISA) could be a good option for you.

While there are several types of ISAs, LISAs are specifically aimed at those looking to buy their first home, or save for retirement. As well as its tax wrapper, the account is an attractive option for savers because it comes with a juicy government bonus in every new tax year.

But, there are stringent rules and breaking them will cost you, with penalties often leaving you worse off. According to the latest annual HMRC LISA saving statistics, which were published on 19 September and cover the 2023/24 tax year, there was a 31% jump in the number of people making so-called ‘unauthorised’ withdrawals. The 99,650 people who raided their LISAs faced a combined £75.3 million in withdrawal charges, or an average of £755 per person.

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These figures came as households across the UK battled the worst cost of living crisis in a generation. Rocketing energy bills and food prices prompted a surge in inflation across the economy, with interest rates then rising to record levels as the Bank of England sought to bring things back under control.

The latest HMRC data has led to renewed calls for LISA rules to be eased by Chancellor Rachel Reeves in the Budget. Industry experts argue that it is unfair to penalise savers who urgently need to access their money. They also say that the current way in which the LISA works is inadequate due to the affordability challenges that have been raised by near-record house prices and high mortgage rates, as well as the soaring cost of retirement.

So, is the LISA still worth it - and what are the rules you have to abide by if you open one? Here’s everything you need to know.

How does the Lifetime ISA work?

Like all ISAs, the Lifetime ISA is a tax-efficient way to save money because any interest and investment gains are tax-free. You also get a cool 25% government bonus of up to £1,000 per tax year. For example, if you pay £2,000 into your LISA in a tax year, you’ll receive a £500 top-up.

To open one, you must be aged between 18 and 39. You can then pay in up to £4,000 each year until you turn 50. This money counts towards your annual ISA limit (£20,000 for the 2024/25 tax year). Like adult ISAs and junior ISAs, you can hold cash or stocks and shares in a Lisa, or a combination of both.

The money you build up can be used to buy a first home that’s worth up to £450,000. Or, you can use the money later in life, with penalty-free withdrawals permitted once you turn 60. You can also access the account if you’re terminally ill and have less than 12 months left to live.

But, as we’ve already mentioned, you will get penalised for making a withdrawal for any other reason. The exit charge is 25% of your pot. Not only does this effectively take away the government bonus, but it also eats into some of your own money too.

For example, if you have built up a pot of £10,000, your government bonus would take it to £12,500. An ‘unauthorised withdrawal’ would mean you lose that bonus, plus £625 of your own savings, as 25% of £12,500 is £3,125. So, your initial £10,000 pot would become £9,375.

The exit fee also applies if you try to use the cash on a property costing more than £450,000. “Anyone who exceeds the £450,000 limit, even by just £1, will be hit with the 25% exit charge on the Lifetime ISA, as their purchase will no longer be within the rules,” notes Laura Suter, head of personal finance at AJ Bell.

According to the investment platform, if someone had contributed the full £4,000 annual limit since the Lifetime ISA launched, they’d have a £35,000 deposit saved once the government bonus is added. If they then faced the 25% exit penalty, they would have to pay a charge of £8,750. It means they would end up with £26,250 in savings, £2,250 less than they contributed.

The exit fee was previously reduced to 20% during the pandemic after an outcry over its unfairness – but it reverted back to 25% in April 2021.

Why are Lifetime ISA rules unpopular?

There are a few reasons why experts have been calling for LISA reforms. Firstly, the £450,000 cap on the homes it can be used to purchase is described as being out-of-date.

When the Lifetime ISA launched, the average UK house price was £208,000, according to the Nationwide House Price Index. However, average prices are now £265,375 - just 3% below the all-time high recorded in August 2022.

Official data from Land Registry suggests those in southern England would struggle the most to get on the housing ladder using a LISA. Average prices in the South East (£381,188) and East of England (£341,160) regions are close to the limit, while typical London prices (£520,747) are likely to be out of reach altogether.

Jim Islam, CEO of Lifetime ISA provider, OneFamily, says it’s time for this “outdated” cap to be “urgently” reviewed. “It was set in 2017 and house prices have risen massively in the last seven years. The price cap works against those who have no choice but to live in a location where homes cost more. By updating the LISA, it could become an essential tool in helping the next generation to move out of rented accommodation and into the stability of their own homes,” he says.

Research carried out by OneFamily has found that there would be more demand for Lisas if this cap was removed. Polling for the firm by Opinium in February 2024 found more than a third of eligible adults who don’t have this type of ISA would be more likely to get one if the restriction was ended.

Another major criticism of LISA rules is how they are enforced. Commentators say the penalties for early withdrawals are too harsh. Rachael Griffin, tax and financial planning expert at Quilter, says the latest HMRC data (see above) is worrying.

“These concerning figures illustrate just how many people continue to face a difficult battle over the need to save for the future versus the need to pay their bills, and higher costs have clearly won as so many have had to stomach the 25% charge to gain access to their money. In what remains a financially challenging time for many, we should not be overly penalising people for using their hard-earned savings. Yet, the punitive 25% penalty means that those who have done the right thing by saving are penalised if they need to access their cash.

“The figures reiterate the desperate need for reform of the Lifetime ISA. The LISA attempts to fix two polar opposite problems; saving for a house and saving for retirement, and fails to do either adequately with even its name not alluding properly to either of its main purposes. What’s more, they are treated like an ISA for a means test assessment for Universal Credit, yet they carry an early withdrawal charge like a pension – it is the worst of both worlds.”

Griffin adds that the system should be made fairer, with any penalties solely removing the government bonus instead of raiding the person’s savings. She suggests the government should drop the penalty from 25% to 20% - a figure Islam also believes would be better.

Is the Lifetime ISA still worth it?

A 25% bonus on top of your savings sounds very attractive. It’s a much higher annual rate than you’d be likely to get from other forms of ISA.

The key consideration is whether its rules match your savings goals. Say you live in an expensive area for house prices, you would have to ask yourself whether you are content with solely leaving the money for retirement.

And, if you do believe a LISA matches your aims, you would also need to think about how secure your finances are in the here and now. Given how hefty the fees are for breaking the rules of the account, are you prepared to take the 25% penalty on the chin if a crisis means you need to withdraw early?

As with all financial products, it’s important to understand the small print and also to think about your own personal circumstances. Your age, financial goals, amount you can save and attitude to risk will also be factors in deciding whether a LISA is worth it.