Budget 2016: Lifetime ISAs

At present individuals may invest in an ISA or a pension. The benefit of investing in an ISA is that funds can be withdrawn at any time. The benefit of a pension is that tax relief is available on contribution but the drawback is that you cannot access the funds until reaching retirement age (55). Many people, particularly the young, must choose whether to invest in an ISA so they can purchase their first home, or a pension and save for retirement.

From April 2017, individuals under the age of 40 will be able to open a Lifetime ISA and contribute up to £4,000 in each tax year. For every £4 contributed to the Lifetime ISA, the government will contribute £1. Individuals will be able to make Lifetime ISA contributions and receive ‘top-up’ contributions from the government from the age of 18 up to the age of 50. Over their lifetime individuals will be able to make contributions of £128,000 matched by government contributions of £32,000.

Funds may be withdrawn tax free to:

  • purchase a first home worth up to £450,000 at any time from 12 months after opening the account; and/or
  • for any other purpose from the age of 60.

Funds may be withdrawn at any other time but, unless the individual has a terminal illness, the government ‘top-up’ will be lost and the individual will suffer a 5% charge.

The government will explore the possibility of allowing individuals to borrow funds from the Lifetime ISA without incurring a charge if the borrowed funds are fully repaid.

This is welcome news for basic rate tax payers, particularly those wishing to save for their first home. The tax relief is broadly equivalent to that of contributing to a traditional pension but with the added advantage that there will be no tax charge when cash withdrawals are made on retirement. Further, there is more flexibility in relation to withdrawing funds before retirement.

For higher and additional rate tax payers, a choice may need to be made as to whether to contribute to a traditional pension scheme – and receive greater tax relief on contribution but pay tax on withdrawals on retirement – or to contribute to the new Lifetime ISA, where tax relief on contributions is more limited but there is no tax on withdrawals on retirement.