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Saving for retirement? This ISA ‘trick’ could generate £2,000 in the next two months

Would you like to earn a 25% return on your cash savings in two months, tax free and with zero risk? Today, I’d like to talk about an offer of free money that’s backed by the UK government. If you’re in a position to take part, I think it’s worth considering.

What’s the deal?

The secret to this money-spinning goodness is a special type of ISA account called the Lifetime ISA, or LISA.

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The LISA is designed to help people saving for a deposit to buy their first home or saving for retirement. You can open one if you’re aged between 18 and 39 and can pay in up to £4,000 each tax year, until you’re 50.

Each year, the government will pay you a bonus of 25% of the amount you’ve deposited. So if you’ve paid in the maximum of £4,000, you’ll get a £1,000 cash bonus.

The new tax year starts on 6 April. If you pay in £4,000 to a Lifetime ISA by 5 April and then pay a further £4,000 after 6 April, you could earn £2,000 of free cash in the next two months.

Getting the cash out

The catch with a LISA is that you can only withdraw the cash and keep the bonus if you’re buying your first home, or are at least 60 years old.

If you do choose to withdraw before you’re 60 and without using the money to buy a first home, then you’ll face a 25% penalty charge. It’s worth noting that this is 25% of the total amount you withdraw. This means that the penalty will be bigger than the 25% bonus you earned on your original deposit.

Put simply, if you withdraw cash early from a LISA, you’ll probably lose money.

The perfect long-term investment?

You can choose to keep your LISA savings in cash. If you’re planning to buy a house in the next few years, then that’s what I’d do. But if you’re using the LISA as a retirement investing tool, then I think it makes sense to put cash into the stock market.

For low cost and simplicity, I’d probably put my LISA cash into a cheap FTSE 100 tracker fund (using accumulation units). The FTSE 100 offers a dividend yield of 4.9%, at the time of writing. There’s also the potential for capital gains over longer periods, as the market rises.

For example, let’s assume that you’re 35 today and will pay in the maximum of £4,000 each year (or £333 per month) to your LISA until you’re 50. Each year, you put all of your cash (including the £1,000 bonus) into a cheap FTSE 100 tracker.

My sums that a LISA invested in this way could be worth more than £280,000 when you’re 60. I think that would be a pretty useful retirement nest egg.

Remember, you can only open a Lifetime ISA before you’re aged 40. If you think you might want one, it might be sensible to open an account today, even if you don’t start paying in just yet.

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Roland Head has no position in any of the shares 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.