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Lifetime ISAs – Free money from the government

Lifetime ISAs are very attractive for those who qualify. However take up has been surprisingly low.

Summary

Posted 2 May 2021

Firstly, what is free money?

For money to be free, somebody has to give it to you, and not take it away later. For example, the tax refund on paying into a SIPP is not free money because when you take money out of the SIPP (apart from the 25% tax free lump sum) you pay tax, possibly at higher rates than your original tax refund.

However, with a Lifetime Individual Savings Account (“LISA”), the government gives you a bonus which it never takes back, provided you comply with the rules.

That bonus is free money.

The basic LISA rules

The LISA rules are set out on the government website page "Lifetime ISA". I have summarised them below:

Contributing to a LISA:

You can take money out of a LISA without any penalties in three circumstances. If you are:

Accordingly, if you pay the maximum of £4,000 into your LISA every year from age 18 to 50, which is 32 years, you will receive £32,000 of government bonus, all of which you keep, plus keeping all of the growth in the LISA, entirely tax free.

If you take money out in any other circumstance, you are charged a penalty of 25% of the money withdrawn.

Since the government bonus only represents 20% of the LISA fund, the 25% is a real penalty since you pay back more than a government’s notional share of your LISA.

Obviously if you follow the rules, the penalty will never arise.

An illustration of the benefits

Assumptions

LISAs started in the income tax year 2017-2018. Assume that you started your LISA on 30 April 2017, contributing £4,000 on that date, and annually thereafter. You invest entirely in equities.

The government bonus normally comes about a month later. For prudence, the model assumes it always comes two months later, on 30 June.

The return on equities fluctuates enormously, with high gains in some years and outright losses in others. For my personal modelling, I always use a nominal total return on equities of 8% per year.

If anything, this 8% figure is slightly below historical long-term experience. For more on long-term equity returns, see my page "Review of "Triumph of the Optimists: 101 Years of Global Investment Returns" by Elroy Dimson, Paul Marsh and Mike Staunton.

Calculations

Using the above assumptions, I have constructed a spreadsheet to illustrate the outcome. You can download the spreadsheet and adjust it if you wish to look more closely at the numbers.

Very briefly, under the above assumptions, by 30 June 2021 your LISA would be worth £29,635.94. This is achieved with total personal contributions of only £20,000 (5 x £4,000). The extra £9,635.94 represents government additions of £5,000 (5 x £1,000) plus investment return on both your contributions and the government additions.

Using the Excel goal seeking facility, I have computed that the internal rate of return on your investment has effectively increased from the basic 8% assumption to 18.4%, because you are receiving an extra £1,000 from the government each year, plus the growth on that extra £1,000.

The effective uplift in the rate of return is lower the longer the LISA is held. For example, if you start at age 18 and contribute until age 50, over the full 32 years the effect of the government addition is to increase the assumed basic rate of return from 8% to “just” 9.06%.

However, the important point is that with the government addition your LISA is worth 25% more than it would be without it.

Under the above assumptions, after 32 years your LISA would be worth £724,753. This arose from your personal contributions of £128,000 (32 x £4,000); the rest represents the government's contribution plus investment return over the 32 years.

Without the free money from the government, it would only be worth 80% of that figure, namely £579,802, lower by £144,951.

National take-up statistics

HMRC publishes statistics annually, but the most recent figures only go up to 2018-2019. In that year, £604,000,000 was contributed to 223,000 LISA accounts, so the average amount contributed was £2,708. The average figure makes sense since there is a £4,000 maximum.

While 154,000 LISA accounts received a contribution in the previous year, 2017-2018, I would expect most people once they had an account open to keep contributing to it. Accordingly, 223,000 is a reasonable estimate for the total number of individuals who had a LISA by 5 April 2019. I would expect the number to have grown since then, but not dramatically.

This contrasts with the figure of 18,576,083 UK resident people in the age range 18-39 shown in the 2011 national census. The take-up is microscopic; approximately 1.2%.

I refuse to believe that the low take up is entirely due to lack of ability to save.

The top 5% (say) of the income distribution would certainly have the resources to save. I expect a much larger proportion of the income distribution than just the top 5% to be able to save in a LISA. Accordingly, the microscopic take-up must derive from lack of awareness.

In my view the LISA is the most generous individual savings product available in the UK, and the low take-up demonstrates appalling widespread ignorance.

The availability of free money is why I put LISAs number 6 in the decision hierarchy in my article “Personal financial planning 101 - The basics” for those young enough to be eligible to invest in a LISA.

Postscript

This page is an expanded version of an article which I wrote for "The Private Investor" which is the house magazine of the United Kingdom Shareholders' Association ("UKSA").

That article was published in TPI issue 211, which at present is only available to UKSA members.

 

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