A cross-party group of MPs has issued a damning report on the Lifetime ISA (LISA), concluding that it “may not be the most efficient use of taxpayers’ money”, with some savers also at risk of losing out.
The Treasury Committee has spent the past six months conducting a review into whether the savings and investment vehicle is still fit for purpose eight years after it was launched.
The dual purpose of the LISA – allowing savers to put money away for a first home or retirement – makes it “complex” and increases the risk of savers choosing “unsuitable investment strategies”, the committee found.
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Its review also pointed to confusion around the LISA withdrawal charge. This risks ISA holders losing a significant part of their savings if they have to unexpectedly draw on the money in unforeseen circumstances, rather than using it for a house purchase or retirement.
MPs were less critical of the house price cap, which prevents savers from using LISA funds to purchase a first home worth more than £450,000, arguing that it “ensures government spending supports those who need financial assistance the most”.
The house price cap is an unpopular feature of the product among savers, with critics arguing that it promotes regional unfairness. The average house price in London is now almost £567,000 according to official figures from HM Land Registry – significantly higher than the cap.
Wealth management firm Quilter said the report “should be the catalyst for serious reform”.
“The Lifetime ISA does not sit comfortably within the wider savings system and trying to make it serve two purposes has only added to the confusion,” said Rachael Griffin, tax and financial planning export at the firm.
“There is a clear opportunity to replace it with simpler, more targeted tools that give people the right support whether they are saving for a home or planning for later life. This should be a major focus of Labour’s upcoming ISA simplification programme this summer.”
What is the Lifetime ISA?
The LISA is a popular savings and investment tool, with around 1.3 million accounts open at the end of the 2023/24 tax year, according to HMRC data cited in the Treasury Committee report.
HMRC told MPs that around 6% of the population eligible for a LISA has held one since the vehicle was launched.
Savers can put up to £4,000 into a LISA each tax year and benefit from a 25% government bonus, worth up to £1,000 each year. The £4,000 counts towards your overall £20,000 annual ISA allowance.
You can choose between a cash LISA and a stocks and shares version, depending on your goals, risk tolerance and investment horizon. Any savings interest or investment returns earned within the account are shielded from income and capital gains tax.
To open a LISA, you must be aged between 18 and 39. The money can later be used to purchase a first home worth up to £450,000 or, alternatively, you can use the savings in retirement. Penalty-free withdrawals are permitted once you turn 60.
A common criticism of the LISA is that it comes with a hefty withdrawal penalty if you take the money out under any other circumstances, for example to cover an emergency cost or to purchase a home worth more than the house price cap.
How much is the Lifetime ISA penalty?
The exit charge is 25% of your pot. Not only does this effectively take away the government bonus; it also eats into some of your own money.
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 Treasury Committee’s report points out that an increasing number of people are making unauthorised withdrawals and incurring the withdrawal charge, “which may indicate that the Lifetime ISA is not working as intended”.
According to the latest annual HMRC LISA statistics, published on 19 September 2024, there was a 31% jump in the number of people making ‘unauthorised’ withdrawals in 2023/24 versus the year before. The 99,650 people who raided their LISAs faced a combined £75.3 million in withdrawal charges, or an average of £755 per person.
LISA: A distraction from more efficient pensions?
The Treasury Committee’s report has highlighted some significant shortcomings. As well as concerns about the withdrawal charge, MPs are concerned that the LISA could be diverting people from saving into more efficient pensions.
During the government review, LISA provider Moneybox reported that 80% of contributions to LISAs following a home purchase were to cash LISAs. “That suggests a significant proportion of retirement savers are relying on cash rather than higher-risk and higher-return investments,” the report said.
A diversified portfolio of investments almost always outperforms cash over the long-term – and those saving for retirement often have several decades ahead of them. This is an appropriate time horizon for taking on investment risk. Meanwhile, the value of cash is at risk of being eroded by inflation.
Those saving into a stocks and shares LISA for retirement could find the vehicle more useful, though.
“The sweet spot of the LISA can rest in its ability to boost retirement savings among the self-employed. This is a group that has long under-saved into pensions,” said Helen Morrissey, head of retirement analysis at investment platform Hargreaves Lansdown.
Hargreaves Lansdown data shows that only 21% of self-employed households are on track for a moderate retirement, compared to 36% of households overall. Morrissey calls it a “pressing issue” and one that the LISA could help alleviate.
“Self-employed people can be hesitant to save into a pension because of their variable income and the fact they can’t access their money until at least the age of 55. This is compounded by the fact that they don’t get an employer contribution,” she said.
“The 25% bonus on a LISA acts in the same ways as basic-rate tax relief on a pension and the money can be accessed if needed, subject to a penalty. Added to this, any income can be taken tax free.”
What is the future of the Lifetime ISA?
The Treasury Committee report concluded that the government “must carefully consider whether significant spending on the Lifetime ISA is the best way of achieving its policy objectives”.
While it endorsed the government’s “ambition to support first-time buyers and encourage long-term retirement savings”, it questioned whether the LISA is the most efficient use of taxpayers’ money in achieving these “disparate objectives”.
The report also raised concerns about whether LISA bonuses risk spending taxpayer money in a way that is not “precisely targeted”.
In documents published as part of the Spring Statement, the government confirmed plans to review the current ISA system. Changes to the LISA could form part of this review.
“ISAs are incredibly popular but political tinkering means a patchwork quilt of products has been stitched together over time. The fact we have the Lifetime ISA at the same time as still having Help to Buy ISAs in circulation illustrates how complex the landscape has become,” said Tom Selby, director of public policy at investment platform AJ Bell.
In his view, the LISA is a “fantastic savings and investment product when used correctly”, but there are nevertheless “several design flaws which need to be ironed out”, including the early withdrawal penalty.
“Even the best-laid plans often go awry and it is unfair to punish people with an exit charge that goes beyond simply recovering the government-funded bonus,” he added. “Reverting to the system used during the pandemic, when the penalty only matched the original bonus received on the account, would be a fairer approach.”
MPs have considered this as part of the review but pointed out that the case for reducing the charge “must be balanced against the impact on government spending”.
“We cannot have a risk-free option where you are investing for the long term, but there is no charge if you take it out… There has to be some penalty or withdrawal charge in a product such as this,” said Treasury minister Emma Reynolds.
She added that there “could be a case for changing the withdrawal charge” – some have suggested reducing it, for example – but added that the government “would have to find money from elsewhere in order to do that”.
