In 2017, the government launched a new savings product, the Lifetime ISA. Initially, savers avoided the offering. There was a lot of misunderstanding about what it offered and the rules surrounding withdrawals and contributions.
However, as more providers have started to offer the Lifetime ISA, over the last few years take-up has gradually increased. Should you join this trend and open one today?
Is a Lifetime ISA right for you?
If you are aged 18-39, you can open a Lifetime ISA. Unfortunately, if you are over 39 you can’t, although if you already own one, you can continue to contribute to your savings pot till age 50.
If you do fall within the age bracket, you can save up to £4,000 every tax year, and the government will add a 25% bonus on whatever you save. So, if you are putting away that full amount every year, the government will give you £1,000 of free cash — not bad.
The big drawback is that you can only use this cash for one of two reasons. Either buying a property for the first time or funding your retirement. What’s more, Lifetime ISA investors can only use funds to buy a property for the first time, if the value of the property is under £450,000. Otherwise, you have to wait until you hit 60 to access the funds. Withdrawals for any other reason will cost you 25%.
The Lifetime ISA does have its drawbacks, but the prospect of £33,000 worth of free cash is alluring. Overall, if you’re eligible, I think it’s worthwhile opening one to take advantage of both the government cash bonus and tax-free nature of the product.
Cash or stocks?
The next question. Is it better to open a cash or stocks Lifetime ISA? I believe the answer is relatively straightforward. At the time of writing, the best Cash ISA interest rate available is just 1.5%, below the current inflation rate.
By comparison, you can achieve a high single-digit to double-digit annual return by investing in stocks. If you have just opened your first Lifetime ISA at age 18, it certainly makes sense to go down this route.
Indeed, a saver putting away £4,000 a year and receiving that £1,000 government bonus between ages 18 and 60 would, according to my calculations, be able to accumulate a pension pot worth £2.3m. This is assuming the money is invested in a low-cost FTSE 250 tracker fund returning 10% per annum.
If the saver put the money in a low-cost FTSE 100 tracker fund, they would still be able to achieve a fantastic return. The UK’s leading blue-chip index has returned around 7% per annum for the past decade. Assuming this rate of return continues for the next 39 years, £5,000 of contributions per annum, including the government bonus, would leave the saver with a pension pot of nearly £1m.
These numbers speak for themselves. It makes a lot of financial sense to open a Lifetime ISA today.
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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.