The Lifetime ISA is in need of a radical overhaul – here's why

(Graph source: UK House Price Index, last accessed on 18 January 2023.)

In London, the problem is most acute, as average house prices were already above the £450,000 cap at the time of the LISA launch. However, the sharp rise in house prices across the UK over the last five years shows that this cap could fast become a problem in other areas if it remains unchanged going forward.

How does the penalty work?

To access your LISA money for any reason other than to buy a home under £450,000 or for retirement, a 25% penalty is applied to the whole LISA pot – this includes the Government's 25% bonus and any interest accrued. The way the maths work out, you're left with a 6.25% hole in the savings you originally put in.

For example, imagine you saved £1,000 and so got a £250 bonus, you'll have £1,250 total (ignoring interest, for ease). If you then withdrew it and closed the account, the 25% penalty would be £312.50. So you'd get £937.50 back.

So let's look at the worst-case scenario. At the time of writing, if you'd saved the maximum amount into a LISA each year since launch, you would have £20,000 of your own savings, plus £5,000 in bonuses, plus interest – totalling over £25,000. If you wanted to get your money out to buy a property over £450,000, you'd lose £6,250 in total (again, ignoring interest for ease). This works out as £1,250 of your own money, gone. A huge loss for a first-time buyer.

What should be done?

Prior to the scheme's launch, the Government said that it was "committed to supporting savers at all income levels and at all stages of their lives". But in order for the Government to meet this aim, those wanting to purchase a property above the cap shouldn't have to lose their own money.

First-time buyers shouldn't be penalised for putting their money into a Government-backed scheme in good faith. The Chancellor must act, or risk LISAs becoming unusable as the gap between the LISA cap and house prices across the UK continues to grow, and the potential penalty becomes ever more expensive.

We've called on the Government to do one or both of the following:

• Reduce the penalty for withdrawing savings from the LISA if buying a home over £450,000 from 25% to 20%, as was in place during the coronavirus pandemic. This would see savers lose the Government bonus, but none of their own money.
• Immediately uprate the LISA cap in line with property price rises, and continue to update the cap alongside property prices automatically each year thereafter. This means that the cap could go up as well as down, depending on changes in house prices each year. In January 2023, when we launched this campaign, we calculated the cap should be increased to £607,500, due to the 35% rise in prices over the last five years.

Update: May 2023

We’ve not yet had a formal reply from the Government, but it has answered some questions asked in Parliament about our recommendations. We continue to work to make sure that it properly understands and takes into account the issue some first-time buyers face as a result of the scheme's rules.

The Government said that the penalty is in place in to recoup the Government bonus and any interest accrued – but it didn't acknowledge that savers are also left worse off than they would be if they hadn’t started using a LISA to save in the first place. We agree that the penalty should ONLY be used to recoup the Government’s bonus, and that’s why we’re calling for the penalty to be reduced to 20%, so savers keep ALL of their hard-saved cash.

The Government has also said that the LISA property threshold of £450,000 is only an issue in inner London. While the problem is certainly most pressing in London at the moment, areas outside the capital are seeing much higher rates of house price growth – meaning that before long, more first-time buyers in other regions could be facing the same dilemma if they want to purchase a property. Keeping the threshold at the current level (which itself was set in 2017) does nothing to future proof it for prospective buyers, who are just starting their journey by saving into a LISA product.

We’ve already heard from MSE users across the UK who are facing issues using their LISA, and if you’d like to tell us your experience – join the conversation on our forum or contact us at campaigns@moneysavingexpert.com.