How would you like to earn extra £2,000 for your portfolio this year? No, this isn’t some dodgy get rich quick scheme or risky trading plan. It is a legitimate strategy to maximise tax benefits available to almost every investor.
Lifetime ISAs were introduced at the beginning of the 2017 tax year to help savers get the most out of their hard-earned cash. The launch was initially a bit of a damp squib as complicated rules about the product meant that many providers refrained from offering it to customers. However, over the past 10 months a steady flow of new providers has seen companies signing up to the scheme and today, there are six such products on offer across the market.
Savers can put away a maximum of £4,000 a year in a LISA and the government adds a 25% bonus on top. This means that if you put away £4,000 a year, you’ll receive an extra £1,000 on top for a total pot of £5,000 before any interest or growth. As you can open one LISA every tax year, this means that over the next four months there’s a total bonus possible of £2,000.
There are some drawbacks to this product, however. Money saved can only be used in retirement or for the purchase of a first home, and you have to be between 18 and 40 to open a LISA. So, if you are over the age of 40, already own a home and are happy with your existing pension provision, then this isn’t a product for you.
On the other hand, if you are 18 with no pension or savings, then the ability to earn a total of £33,000 in extra cash from the government before your 50th birthday (when you can begin to withdraw funds without facing a penalty) may be too good to pass up. Another drawback of the product is that if you remove funds without using them for a home purchase or retirement, withdrawals will be slapped with a 25% penalty, which is equal to the whole government contribution plus an additional 6% from your own money.
Making the most of the tax benefits
The good news is that you can open a LISA and normal ISA as well, so you are not limited by the £4,000 ceiling. For this tax year, the overall ISA limit is £20,000, and you are allowed to split this between a LISA and standard cash/stocks and shares ISA as long as you don’t breach the overall limit.
The gains on offer if you can use the LISA to its full potential are enormous. For example, if you start saving at age 18, putting away £5,000 a year (including the government bonus) and invest this money in a simple FTSE 250 tracker (average annual return over the past decade of around 10.2%), by the time you reach 50 your savings pot will have grown to £1.1m. To hit this target, you only need to contribute around £333 a month and the government bonus, as well as compound interest, will do the rest for you.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.