The Lifetime Isa: Free money - or just too complicated?

The Lifetime Isa is designed to help people save throughout adulthood

It looks like free money. An absolute no brainer, even.

But while the Treasury has confirmed that the Lifetime Individual Savings Account (Lisa) will go ahead in April, others have raised doubts about the whole idea.

The Nationwide has announced it will be boycotting the product, claiming that it is too complicated.

Others, like Standard Life and Fidelity, will launch a Lisa, but not in time for the April start date.

Nevertheless one provider - Hargreaves Lansdown - has announced it will launch one by 6 April 2017.

That will give some savers the chance to earn up to £32,000 in government bonuses.

But critics are warning not just that the product is complex, but that it could leave some investors worse off.

And should you want your money back at any stage, you could pay dearly.

What is a Lifetime Isa?

It is a savings product, designed to help people at two different points in their lifetime:

• When they want to buy their first house or flat

or

• When they want to retire

Savers can only open a Lisa if they are between the ages of 18 and 39 inclusive. They can pay in up to £4,000 a year, but no more. At the end of the first year, the government will add a 25% bonus, ie up to £1,000. From 2018/19, this bonus will be paid monthly. Since you can continue paying into a Lisa up until the age of 50, the potential eventual bonus is up to £32,000.

For most people, this is more generous than the Help to Buy Isa (see below).

How is the money invested?

As with ordinary Individual Savings Accounts (Isas), the money can be invested as cash - or in stocks and shares.

Cash Lisas are expected to pay out the same as Isas. Currently the best instant access rates are around 1% a year.

Such returns are in addition to the government bonus.

Alternatively the money can be invested in stocks and shares, which have potentially higher returns, but which carry greater risk too.

All gains are free of income and capital gains tax.

What are the rules if you want to buy a home?

The money can only be used without penalty if you are a first-time buyer. In other words, you cannot have owned a property before.

The property cannot cost more than £450,000. This is more generous than the Help to Buy Isa, which is limited to £250,000 outside London, but £450,000 in the capital.

Two partners can each use their own Lisas to buy a house together, potentially doubling the government contribution.

A home bought through a Lisa cannot normally be rented out.

What if you want to use the money when you retire?

Once you are over the age of 60, you can withdraw money from a Lisa and use it for whatever you like.

In addition to being used by first-time buyers, it is therefore an alternative to a pension.

A pension is tax free when you pay into it - so the taxman contributes an extra 25% to the amount paid in by basic rate taxpayers - but money taken out after the age of 55 is taxable.

A Lisa is the exact reverse: you will have already paid tax on contributions into it, but money taken out will be tax-free.

Could I use a Lisa instead of a pension?

Most experts urge real caution here.

Anyone who is paying into a workplace pension can expect contributions to be made by an employer, which are likely to be more valuable than the annual Lisa bonus.

The exceptions to this might include:

• Those not paying in to a workplace pension - such as self-employed people, or non-working parents

• Those who have secured the maximum employer contribution on their workplace pension, and want to save more

• Those who are up to their lifetime, or annual limit, on pension contributions

"In most other situations, a pension will make more sense," says Tom McPhail, retirement specialist with Hargreaves Lansdown.

"This is particularly relevant for anyone who can join a workplace pension and benefit from employer contributions."

There could also be a difference in the age at which you are entitled to withdraw money from a pension and a Lisa.

Those currently under 40 - and therefore eligible for a Lisa - will need to be at least 57 before they are able to take money from their pension.

This age will rise further as the state pension age also rises.

Those with Lisas will not be able to withdraw money penalty-free until the age of 60.

What if I need the money sooner?

You can only withdraw money penalty-free if you are buying your first home, you are over 60, or if you have a terminal illness.

All other withdrawals will incur an apparently hefty 25% exit charge, except in the first year (2017/18). See more below.

This breaks down as 20% to recover the bonus, plus an additional 5%. That 5% is partly to make up for the investment growth on the bonus itself.

Nevertheless one investment firm has calculated that the charge could mean an investor losing around 45% of the growth in the value of the Lisa, assuming he or she had it for 10 years, and it were to grow by 4% a year.

"It is disappointing to see the government pushing ahead with an exit fee that looks overly punitive if people unexpectedly need access to their savings," said Tom Selby, an analyst with AJ Bell.

Lisa Caplan, head of financial advice at Nutmeg, warns that some savers could actually lose money.

"If you invest £4,000, you get a 25% top up from the government to make £5,000. If you withdraw early, you will be penalised by 25% which is £1,250, so you will be left with £3,750, 6.5% less than your initial investment."

When will the bonus be paid?

In the first year (2017/18) the bonus will be paid at the end of the 12 month period. In subsequent years it will be paid on a monthly basis.

In December 2016 the government said this was the reason why the exit penalty would be not be applied in the first year - as otherwise some investors might have to pay the penalty before they had received the bonus.

Help to Buy Isa, or Lifetime Isa?

Both products pay a 25% bonus if you are buying a house for the first time. But if you plan to save for more than five years, or if you can afford to put more than £2,400 a year in to the plan, a Lisa will typically be more generous.

Here's why:

• You can put more money into a Lisa (£4,000 a year, v, £2,400 a year into a HTB Isa, plus £1,200 when it is opened)

• The Lisa pays a bonus at the end of each year. The HTB bonus is only added when you buy a house. So the Lisa will benefit from annual compound interest, boosting savings.

• The maximum bonus for a Lisa is £32,000, v £3,000 for a HTB Isa.

• Lisas can be used to buy a property up to £450,000 anywhere in the UK. Outside London, HTB Isas are limited to homes worth less than £250,000.

• The Lisa bonus will be available for exchange of contracts. The bonus on the HTB Isa is only payable on completion.

HTB Isas can only be opened up to 30 November 2019.

Can I save into both?

Yes, you can save into a Help to Buy Isa and a Lisa at the same time, subject to the annual limits. But you can only use the bonus from one to buy a property.

If you use the HTB bonus, you would then be subject to a 25% exit penalty on the Lisa, even if you use those funds to buy a home.

If you use the Lisa to buy a home, you won't get the 25% bonus on the HTB Isa.

So it will make sense for many people to transfer funds from a HTB Isa into a Lisa from April 2017.

From that date, the total amount you will be allowed to save in all Isas will be £20,000 a year.

One other warning: because Lifetime Isas are savings accounts, money in them can affect your entitlement to benefit payments.