The State Pension gets a lot of media coverage. It’s often the first thing people think about when planning for retirement. But the reality is that this £168.60 per week payment isn’t always enough to live on.
Many of us are likely to need an extra source of retirement income. A private pension is one option, but these can be expensive.
In recent years, the Lifetime ISA has provided a new low-cost alternative. It offers tax advantages and the same kind of ‘free money’ that’s available to pension savers.
What is the Lifetime ISA?
A Lifetime ISA is a new type of individual savings account (ISA). It’s designed to help you save for your first home or save for retirement.
It offers the same tax-free advantages as a regular ISA, so income and capital gains earned inside the account won’t be taxed. Future withdrawals are tax-free, too.
However, the Lifetime ISA has three special features that make it very different than a regular ISA.
Free money: You can save up to £4,000 per year in a Lifetime ISA. The government will add 25% to this each year. That means you can receive up to £1,000 of free money each year.
You can hold cash or stocks and shares in a Lifetime ISA, just like in regular ISAs.
Age limits: You can only open a Lifetime ISA if you’re aged 18–39. You can then pay into the account and receive your annual 25% bonus until you are 50. After that, no further contributions are possible.
Withdrawals: You can only withdraw money freely from a Lifetime ISA in three specific situations:
- Buying your first home (under £450k)
- If you’re aged 60 or over
- If you are terminally ill, with less than 12 months to live
If you withdraw money from a Lifetime ISA at any other time, you will pay a 25% charge on the money you withdraw. That basically means the government will reclaim the bonus cash it provided in previous years.
Retire as a millionaire
I’m too old to open a Lifetime ISA. But for younger investors, I think it is an incredible opportunity to build long-term wealth.
If you open a Lifetime ISA when you’re 18 and pay in the maximum each year until you’re 50, then you could receive £32,000 in bonus payments from the government, completely free.
I’ve done some sums to show how these annual bonus payments could help you retire as a millionaire.
I’ve assumed that you’ll invest all of your cash in a cheap FTSE 100 tracker fund and I’ve based my projections on the long-term average annual return from the UK stock market, which is about 8%:
|
Amount saved each year (ages 18–49) |
Lifetime ISA value at age 60 |
|
£4,000 |
£1,159,028 |
|
£5,000 |
£1,448,785 |
As a result of the extra £1,000 bonus each year, I estimate that your account could be worth an extra £289,757 when you reach age 60.
Of course, this depends on you starting at 18 and making the maximum payments. But even if you don’t get started until you’re in your 30s, I think a Lifetime ISA has excellent wealth-building potential.
What next?
If you’re under 40, then you’ve still got time to open a Lifetime ISA. I’d strongly recommend it as a way of saving for retirement or for a deposit on your first home.
