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Forget a Cash ISA! Why I think a Lifetime ISA is a better way to build retirement savings

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While the FTSE 100’s fall in the last six months may be causing investors to seek less risky assets, a Cash ISA is likely to deliver disappointing returns in the long run. Certainly, returns on cash can outperform those of stocks over a short time period. But in the long run, history shows that buying a variety of FTSE 100 and FTSE 250 shares could prove to be a better option.

One means of doing so is through a Lifetime ISA. They are available to anyone under the age of 40, and could provide an appealing mix of flexibility, high returns and simplicity in order to deliver a boost to an individual’s retirement savings potential.

Returns

Perhaps the most important factor when planning for retirement is the returns which are on offer. After all, most people have a long-term view when it comes to planning for retirement, so they can often afford to experience a significant amount of volatility in the short run.

A Lifetime ISA offers investors the chance to receive a bonus from the government. They receive a 25% bonus for every £1 of the first £4,000 they invest per annum. This means that they could receive up to £1,000 per annum in a bonus. For an 18-year old looking to open a Lifetime ISA and invest £4,000 per year, this could lead to a government bonus of £32,000 over the course of a lifetime, since it is payable until age 50.

In contrast, a Cash ISA’s appeal has declined due to the fact that the first £1,000 of interest received in standard savings accounts is tax-free. This means that the tax benefits of a Cash ISA have been diluted – especially at a time when interest rates are low. In fact, in the long run a Cash ISA is currently expected to provide a return which is less than inflation. This means that the purchasing power of amounts saved in one is likely to fall.

Practicalities

Unlike a workplace pension or SIPP, amounts paid into a Lifetime ISA can be withdrawn at any time. While they are subject to a 25% penalty, unless the money is being used to purchase a first home or an individual is above age 60, this could make them useful in case the capital is required in the short run. As such, a Cash ISA may provide greater flexibility than a Lifetime ISA, but not enough to make the latter unappealing to investors who are concerned that they may require cash savings before they retire.

Once an individual reaches 60, any amount can be withdrawn from a Lifetime ISA without penalty. Given that the FTSE 100 and FTSE 250 could deliver high single-digit returns per year over the long run, according to their track records, amounts saved through a Lifetime ISA could be significantly higher than those in a Cash ISA. As such, it seems that for anyone under 40, a Lifetime ISA could be a much more worthwhile means of investing for the future than the cash variety.

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