The £75m Lifetime Isa penalty

The government is being urged to reform the Lifetime Isa in next month’s budget to stop thousands of savers from losing chunks of their money.
Savers paid more than £75 million in penalties on withdrawals from Lifetime Isas in the 2023-24 tax year, according to HM Revenue & Customs data.
The tax-free savings accounts are designed for saving for a first home or retirement and can be opened by adults under the age of 40. You can put away up to £4,000 a year until you are 50, and get a 25 per cent top up on your savings from the government. If you saved the maximum £4,000 a year from the age of 18, you would get a total bonus of £32,000.
But there is a catch: if you use the money for anything other than buying your first home, or after you turn 60, you will pay a 25 per cent penalty on withdrawals. This means that you lose the bonus as well as some of your own savings.
Campaigners say this is too limiting and want the rules to be overhauled so that those who need to make a withdrawal for emergencies are not unfairly penalised.
Lifetime Isas were introduced in 2017 as a replacement for the Help to Buy Isa, and quickly gained popularity. Some £2.4 billion was saved into 767,000 accounts in the 2022-23 tax year, up from £1.7 billion into 662,000 accounts the year before. So far they have been used to buy 227,600 homes. The total value of bonuses awarded to savers under the scheme is £1.99 billion.
But the number of savers paying penalties for “unauthorised withdrawals” (taking out money that isn’t for a house deposit or retirement) is increasing too. In 2023-24 99,650 savers paid £75.3 million in withdrawal charges. The year before, 76,000 savers paid £54.3 million, according to HMRC. The average amount taken in an unauthorised withdrawal was £3,022 in 2023-24, up from £2,859.
The 25 per cent penalty means that you are losing more than just the bonus. If you had saved £4,000 in a year and earned a 25 per cent bonus, you would have £5,000. If you withdrew that to buy a car, for example, you would trigger a 25 per cent penalty of £1,250, leaving you with £3,750 — less than you started with.
“The penalty is hugely unfair, because it takes away some of your hard-earned savings,” Rachael Griffin from the wealth manager Quilter said.
Campaigners are urging the chancellor, Rachel Reeves, to reduce the penalty in her budget on October 31.
Laura Suter from the investment platform AJ Bell said: “The 25 per cent early withdrawal charge effectively acts as a 6.25 per cent exit penalty. It is deeply unfair and punishes those for whom a change of circumstances means they can’t pursue their homeownership aspirations.”
If the penalty was 20 per cent, savers would simply lose the bonus. In the above example, you would lose £1,000, leaving you with your original £4,000.
The penalty was reduced to 20 per cent in March 2020 so that savers could get at their money during the coronavirus pandemic, but was put back up again in April 2021.
“The reality is that many people aren’t in a position to save at the moment, and are taking money out to use for day-to-day living, expenses or luxuries like paying for a holiday,” Griffin said. “Reducing the penalty is a crucial reform that needs to be made to the Lifetime Isa.”
The government has said that the penalty is there to protect the Lifetime Isa’s status as a long-term savings product.
Savers can also be charged a withdrawal fee if the property they want to buy with their savings is too expensive. Lifetime Isas can only be used to buy a first home worth up to £450,000.
This cap has not changed since the accounts were introduced in 2017, when the average cost of a property in England was £235,021. Today the average house price is 30 per cent higher at £305,879 while in London it is £520,747.
If the cap had risen in line with house prices it would be £585,000 today and you could still buy the average home in London without paying a Lifetime Isa penalty.
“First-time buyers in premium postcode areas will find it increasingly difficult to find a home within this price range unless the limit is changed soon,” Helen Morrissey from the investment platform Hargreaves Lansdown said. “It’s really important that the £450,000 limit on first homes bought using a Lifetime Isa is increased.”
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Critics also say that the Lifetime Isa age limits are too restrictive. If you are 40 or over you cannot open an account and you cannot save into one beyond the age of 50, which is odd in a product partially aimed at encouraging saving for retirement.
It could put self-employed workers, who do not benefit from being automatically enrolled into a company pension, off from using a Lifetime Isa as part of their retirement saving plans.
Lifetime Isas have been touted as an alternative to a self-invested personal pensions (Sipps) because the 25 per cent bonus is equivalent to the tax relief that a basic rate taxpayer gets on pension contributions.
Many self-employed workers are reluctant to set up a pension because anything saved in it cannot be accessed until they are 55 (rising to 57 from 2028). They prefer a savings account that they can use if they need money in a hurry for their business. But the Lifetime Isa has the same drawback.
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Scrapping the withdrawal age limit or expanding the window within which savers can open an account could encourage more people to set money aside for retirement, campaigners say.
The latest official statistics suggest that there are 4.3 million self-employed workers in the UK, including 2.1 million who are 50 and over and so cannot save into a Lifetime Isa.
Andrew Chamberlain from the Association of Independent Professionals and the Self-Employed said: “If there is an age limit on new accounts at all, it should be lifted to 55 to give mid-career professionals more savings options when they go freelance.”
A Treasury spokesperson said: “While the average price for a first-time home has increased, it remains below the £450,000 Lifetime Isa cap across the vast majority of the country.”
Archie Marshall will have to wait 39 years before he can access the savings in his Lifetime Isa — unless he is willing to pay a hefty penalty.
Marshall, 21, from East Midlands, set up his stocks and shares Lifetime Isa with AJ Bell in 2021. Since then, he’s been saving the maximum £4,000 a year into his account.
However, unlike most people his age, Marshall, who is a civil servant, will be using his Lifetime Isa for his retirement, and not his first home.
That’s because he has already used a Help to Buy Isa to get on the property ladder. These accounts were discontinued in November 2019 and replaced by the Lifetime Isa. Savers can only use the government bonus from one of the accounts to buy a first home.
Marshall bought a two-bed house for £207,000 in April 2022, when he was 19, using the £10,500 saved in his Help to Buy Isa for a deposit, which got him a 25 per cent bonus from the government. of £2,625.
But this means Marshall now won’t be able to touch the savings in his Lifetime Isa until he turns 60. If he accesses his money before then, he will have to pay a 25 per cent penalty.
Marshall is planning to keep saving the maximum £4,000 a year into his Lifetime Isa, which means he could earn a total bonus of £32,000.
But he has only just discovered that the 25 per cent penalty means that if he does need to access his savings pot before age 60, he will forfeit his bonus as well as some of his own money.
“It’s frustrating. Initially, I thought it wouldn’t be the worst thing in the world if I had to dip into my savings, because I wouldn’t lose any of my own money. But now I will have to be much more disciplined,” said Marshall.
“It would be good for the government to reduce the penalty rate from 25 per cent to 20 per cent so that if you have an emergency and need to dip into your savings, you don’t lose your own money, otherwise I’ll never be able to touch my account”