The Budget’s Lifetime ISA Is A Game-Changer

The budget’s announcement of a Lifetime ISA for people aged under 40 is hugely significant because it could change the way people invest. While the details are somewhat vague at the present time, the fundamentals of the Lifetime ISA are that it will be available to anyone under the age of 40 and will act as a hybrid between a traditional pension and an ISA.

More flexible

For example, amounts added to the Lifetime ISA would be from after-tax income (as is the case for the ‘standard’ ISA), but the government would then top up the amount by 25%. This essentially means that it offers the same tax benefit as a traditional pension for basic rate taxpayers, since the government tops up pension contributions by the amount of income tax paid at the present time.

However, the Lifetime ISA will be more flexible than a traditional pension. The amount invested will be available to be put towards a house after just one year, and will be able to be withdrawn tax-free from the age of 60 for retirement. With a traditional pension, no withdrawals are allowed until retirement, with them then generally being subject to taxation.

Less flexible

Of course, the Lifetime ISA is not quite as flexible as a ‘standard’ ISA, since with the latter the money can be withdrawn at any time for any purpose. However, it will provide the government bonus and, in many people’s eyes, will provide sufficient flexibility regarding a house deposit to merit contributions from a relatively young age. And with house prices being so high relative to incomes, it is understandably highly challenging for younger people to save enough for a house deposit while also planning for their retirements. So the Lifetime ISA is likely to be very popular.

If an individual were to utilise a Lifetime ISA from a relatively young age, it could provide them with a healthy house deposit and a generous income in retirement. The following illustrations assume an annual return of 9.1%, which is the FTSE 100’s annualised total return since its inception in 1984. 

For example, if an individual invested the full £4,000 each year from the age of 21 and they benefitted from the government’s £1,000 bonus each year, they would have a deposit of over £65,000 by the age of 30 for a house.

This could be withdrawn tax free, and the same individual could then contribute the same £4,000 per year until the age of 60, thereby generating a retirement fund of almost £680,000 (the government bonus of £1,000 per annum is only available until the age of 50). 

Clearly, in the coming years the rules surrounding the Lifetime ISA are bound to change, and the scheme may become more or less generous at any given time. However, today is a very good day for younger people since it provides them with much-needed help to not only get on the property ladder, but also to plan ahead for their retirement.

With that in mind, the analysts at The Motley Fool have written a free and without obligation guide called 5 Shares You Can Retire On.

The 5 companies in question offer stunning dividend yields, have fantastic long term potential, and trade at very appealing valuations. As such, they could deliver excellent returns and provide your portfolio with a major boost in 2016 and beyond.

Click here to find out all about them - it's completely free and without obligation to do so.