Free Money – Who wants an extra £250,000 tax free?

Who would like a tax-free birthday present of £250,000, for free?

Me please, whats the catch? How much is it going to cost?

The cost to you, my friend? – Zilch, Nada, Zippo, Zero, Nothing!

This is a scam, right?

No.

So what gives?

The UK government has given a generous tax break that gives you free money when you contribute to a certain type of investment account.

Oh, you’re talking about pensions, right?

No, in addition to tax relief in a pension, you can get tax relief in another savings vehicle.

What’s that, then?

It’s called a LISA (Lifetime ISA.)

Oh, I’ve heard of them, and I can’t see any advantage over investing in an ordinary ISA.

I didn’t think so either, until I started looking at LISAs in a bit more depth, and running some numbers.

But doesn’t it tie your money up? Whereas in an ordinary ISA you can access it at any time?

Yes, that is correct. But you can use it if you are a first-time buyer for a house deposit, or you can withdraw it in full, tax-free when you are 60.

So, why would I bother then?

Because for every £4000/year you contribute, the government will top it up with a 25% bonus to £5000. Not a bad investment return.

So,  how do I get my free £250,000 then?

First, we assume that you have £4000 per year available to invest, and the money you put in a LISA would have been invested anyway and that you make the maximum contribution of £4000/yr. This can be by regular contributions or by a lump sum.

Ok, and how long do I have to make these contributions for?

To get the full amount of free money you will have to contribute £4000 per year, from when you can open a LISA at the age of 18, to the age of 50, after which no further contribution can be made. A total £132,000 worth of contributions over 33 years.

What happens then?

You wait a further ten years until you are 60, and voila, you can withdraw a total of £1,250,000, tax-free! Happy days.

Hang on, I thought you said £250,000, isn’t that a typo?

No! The total value of the LISA is £1,250,000 (£1.25 million!). The “free” £250,000 is the extra value as compared to an ordinary ISA would be if the same contributions were invested for the same period.

OMG

Happy 60th Birthday!

Oh, great, thanks. Wait a minute. how did you work those figures out?

I worked it out using a very good compound interest calculator on the excellent Monevator website here.

Go on.

Firstly I calculated what the value of investing £4000/yr in a S&S ISA for 33 years at assumed 7% growth per year would be. This came to £509,035. Then, this is left for a further 10 years, giving a total of £1,001,349.  The equivalent calculation in a LISA gave a total of £1,251,687. A difference of £250,338 for the exact same contributions.

Wow, that sounds great. Are there any further downsides?

There are further things to consider that may have to be taken into account before investing in LISA’s that I will explore in my next post. These include exploring the mix of investments to use, as already explored by youngfiguy here. Also maybe looking at how investing in a LISA at different ages compares, and potential funding gaps between FI and being able to draw on the LISA.

 

 

What do you think?

Has reading this post made you consider/reconsider LISAs, or do you think they’re a waste of time?

Does my maths add up?  Weenie? 🙂

As always, comments, critical or otherwise, are gladly accepted.

 

I am taking part in the Monday Money linky with Lynn from Mrs Mummy PennyFaith from Much More With Less and Emma from EmmaDrew.Info

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12 Responses to Free Money – Who wants an extra £250,000 tax free?

  1. It’s just a shame that you have to be under 40 to open one. I know they are aimed at younger folk, but still..

  2. Ms ZiYou says:

    I have to say I’m not a fan of LISA’s the penalties are so harsh for early withdrawal – you lose more than the bonus. Hardly anyone offers them due to this, hence there is not much price competition.

    Not to mention if you are saving for a house deposit you probably want to save in cash, but for investment you want to invest in the stock market. And if you want to buy a house, these funds are only available at exchange, so cannot be used as a deposit.

    For most people, saving into a pension offers better value for money. Pension tax relief is more, the access age is earlier and pensions cannot be taken if you bankrupt/need benefits.

    I can only see a benefit for saving for a first home, or very high earners that have maxed out their pensions, pension carry forward, who have lots of other savings or investments and definitely will not need the money before 60.

    • FU MON CHU says:

      Hi Ms ZiYou

      Thanks for commenting.

      There are restrictions and penalties, as with any investment, but as long as you are aware of the restrictions and use accordingly, LISAs can be very profitable. As you say, the main benefit probably is if you are buying a house, but there are other benefits too, and I think there are a few more providers about now than when they first came out.

      With regard to saving for a house deposit in cash, this probably depends on your risk tolerance. If you are saving for a house deposit over a 5-10 year period, I would have no problem putting it in the stock market, especially with monthly contributions, and the 25% bonus probably provides plenty of buffer if the markets did drop. You simply cannot get that type of return on cash savings. Also, for example, my son holds his LISA in Hargreaves Lansdown, and you can hold the money as cash in this account if you want, or invest in stocks/funds as you see fit.

      On deposits, I understood that the funds could be used for both a home deposit and a mortgage deposit. I could be wrong?

      Pensions offer better value if you are a higher rate tax-payer, but I think if you are a basic rate taxpayer the tax relief is the same, and yes you can access pensions 3 years earlier than a LISA. Your point regarding bankruptcy/benefits is correct but I don’t think this will be a concern to anyone on the FI path, and it is only the same position as with regular ISAs.

      The main advantage over pensions is that LISAs can be withdrawn completely tax-free, whereas with a pension you will be taxed at your prevailing rate.

      I am not advocating for or against LISAs. Everyone’s circumstances are different, but I think LISA’s can be very useful as part of an overall investment strategy as long as you are aware of the restrictions.

      Thanks again for commenting. I really enjoy reading your blog. Keep it up.

  3. weenie says:

    Sums look fine to me, 😉

    As mentioned, it’s a shame it’s just for under 40s, as I would have probably opened one as part of my retirement plans.

  4. YoungFIGuy says:

    Fun post Mr Chu. I’m more in MsZiYou’s camp on LISA’s and agree that the penalties on LISA’s are very harsh. I’ll add that if you are planning to use a LISA for buying a first home, read the T&Cs carefully. For example, inheriting (by pure chance) a part share of a property can rule you out. Remember it can also only be used for residential property worth less than 450,000 and the government has made no promise to change or increase this over time.

    However, I understand, that unlike the HTB ISA, a LISA can be used for both the mortgage and home deposit.

    The tax relief is very generous and really the only things that beat it are employers contributions into an occupational pension scheme or for 45% tax payers who are able to make pension contributions that removes the Annual Allowance taper on them.

    For me, as I’m a home earner they are a much lower priority so I won’t be using them for a while. It’ll give me time to see whether the government tinkers with them.

  5. Emma Drew says:

    LISAs are such a great opportunity for people under 40, and the sums really add up! There are also some good cashback deals around for them on sites like Quidco and TCB, so definitely worth a look!

  6. Faith Archer says:

    If I was under 40 and a first time buyer, I’d grab the free money from a LISA with both hands! For retirement, I’m still keen on pensions, especially for people who can get employer contributions or higher rate tax relief. But whether you use Isas or pensions, great job explaining how compounding can make such a massive difference. Thanks a lot for taking part in #MondayMoney!

  7. Interesting post Mr FU!

    I have to admit I kinda switched off reading about them when they first got announced as it just seemed like another way to lock up my money until roughly normal retirement age… not that helpful for a wannabe early retiree!

    Thanks for explaining it a little better so my tiny mind can grasp the true benefits 🙂

    However, like other commenters, I still don’t quite see the point of them unless you are already maxing out your pension contributions, which is pretty hard seeing as they are quite high. I guess you could do a 50/50 split with extra contributions (say £2K LISA, £2K SIPP) per year just to give some kind of diversification, and also thinking about it, just in case your pension/SIPP starts to hit the lifetime allowance later on (a boy can dream, right!?) then it makes sense to at least open a LISA now.

    I am presuming I could open one at my current age (36), chuck a grand or two in there, then leave it a for a few years and still carry on topping it up again when I’m past 40… that is quite a cool feature if that is the case, then you could see how your SIPP was going and it kinda keeps your options open at least.

    Food for thought! Thanks again!

    • YoungFIGuy says:

      Hi TFS – you are absolutely right that you can chuck a grand in before 40 and leave it there. You can keep getting the government bonus up to age 50. So it’s worth considering putting a small amount in a LISA pre-40 if you are thinking about keeping it open as an option.

    • FU MON CHU says:

      Hi TFS / youngfiguy

      Thanks for commenting.

      Yes definitely pensions first, especially if, as Faith points out above, you get employer contributions or higher rate tax relief.

      You suggest a good idea to open one anyway with a few pounds before hitting 40 so as to be able to keep options open, especially if you may hit the pensions lifetime limit. It may also help or be used to keep the tax down that may be payable on income in retirement.

      Glad it’s helped. As a newbie blogger, I write these posts wondering if they’re of any interest or use to anyone, or if i’m just writing what has all been said before.

      Cheers

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