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

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

Imagine – you've done all the hard work to buy your first home. You've scraped together a deposit and found a suitable, affordable mortgage.

Back in 2017, you chose to save for your deposit in a newly-launched Lifetime ISA (LISA) – a savings account which gives you a 25% bonus from the state on up to £4,000 of your own savings each year, as long as you are using the money for a property under £450,000, or for retirement. As a first-time buyer, it was a no-brainer.

But as you come to search for your dream home in 2022, you find that house prices in your area have sky-rocketed since the time you started saving – on average, they've increased by 35%.

This might very well mean you need to buy a property over £450,000. If so, you find you'll have to forfeit the Government bonus and any interest you've gained PLUS face a shocking 6.25% penalty from your OWN savings to access the funds in your LISA account. If you'd maxed out your LISA from 2017 to 2022, this personal penalty could total over £1,000.

In this scenario, you're left with only two options:

  • Accept the penalty, which may reduce your savings by £1,000+, and therefore potentially your deposit and buying power.
  • Leave your money in the LISA until you reach 60 and find your deposit by other means.

We don't think this choice is a fair one, especially in this cost-of-living crisis where every penny counts.

Savers who put their money into a LISA in good faith should not have to pay to access their own hard-saved cash in order to purchase a property above the cap. The sharp increase in house prices mean many could not have predicted they'd be in this situation when they started saving. The penalty for these buyers needs to go, or the LISA property price cap needs to catch up to the hike, and rise (or fall) every year in line with house prices – or both.

Our report reveals that the change we're calling for is vital to future-proofing the LISA for the next generation of savers and ensuring the rules continue to reflect the reality of the housing market for first-time buyers.

This blog is about our campaign calling on the Government to change the LISA rules, but if you'd like more info about LISAs and whether they could be the right savings product for you, go to our Top Lifetime ISAs (LISAs) guide.

Here's the detail…

Briefly, Lifetime ISAs were launched in 2017 as a way for those aged 18 to 39 to save for either their first home, or for retirement. The Government tops up the money saved into the LISA account by 25%, up to a maximum of £1,000 over the course of a year. If you're saving for a first home, this easily gives you the best return on your money.

However, to use these savings and still get the bonus for a first home, the saver would need to be buying a property under the price cap set in the LISA rules, which is £450,000, and has been since 2017. For pretty much all savers, accessing LISA savings for any other reason (apart from retirement) comes with a 25% penalty – which means they'd lose a chunk of their own savings too. See more on how this works below.

MSE has heard from many would-be first-time buyers who, in 2017, did not imagine they'd be looking at homes costing over £450,000, so reasonably put their money into a LISA account. They're now disappointed to find that they'll have to sacrifice a portion of their own savings to get their money out so they can purchase a suitable first home.

That's because, on average, house prices have risen by 35% between 2017 and 2022 (according to the UK House Price Index), while the LISA cap has stayed the same.

A graph showing average property prices at the time of the LISA's launch in April 2017 and in November 2022. Average property prices in the UK were £218,642 in April 2017 and £294,910 in November 2022, which represents a 35% increase over that time. In London, average property prices were £479,790 in April 2017 and £542,311 in November 2022, a 13% increase. In Northern Ireland, it was £127,178 in April 2017 and £176,131 in November 2022, a 38% increase. In Wales, it was £149,900 in April 2017 and £220,366 in November 2022, a 47% increase. In Scotland, it was £141,091 in April 2017 and £191,492 in November 2022, a 36% increase. And in England, it was £235,021 in April 2017 and £315,073 in November 2022, a 34% increase.

(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.

We've not yet had a response from the Government on our calls, but we will update this blog when we do.