Lifetime ISAs cause some savers to lose their own money and need reform, report warns

MPs have warned that those who invest in a Lifetime ISA (LISA) may get back less money than they put into the scheme.

LISAs are a product for first-time homebuyers or savers for pensions where they can put up to £4,000 in per year and the government will top up that figure by an additional 25 per cent. They can be opened by any adult under 40 in the UK and contributions count towards each person’s overall £20,000 annual ISA allowance.

However, their dual-nature has long been a target of criticism, as well as the complex criteria for using the funds, which has led to many people losing more than they initially save. The £450,000 restriction on how much a house can be worth has not changed with rising property prices, while two different variations of the LISA exist to further skew matters – one in cash, and one where money within it can be invested.

A Treasury report said in 2023-24 that a total of 99,650 people made unauthorised withdrawals from Cash LISAs – in other words, taking their money out other than to buy a new home or to take a pension – compared with 56,900 who actually used it to purchase a house.

When removing money from the account for any reason other than the stated allowed uses or in case of terminal illness, a 25 per cent fine is levied on the cash. However, this means an effective penalty of 6.25 per cent on people on their own money, not just the return of the government’s cash.

The government report called this penalty “nonsensical”.

“Cash LISAs may suit those saving for a first home but may not achieve the best outcome for those using it as a retirement savings product, as they are unable to invest in higher risk but potentially higher return products such as bonds and equities,” a Treasury report said.

Rachael Griffin, tax and financial planning expert at Quilter, commented after the investment company’s evidence was used to show the Lisas were “fundamentally flawed and not always delivering good outcomes for savers”.

“We’re pleased that committee acknowledged Quilter’s evidence on its dual purpose being confusing for savers,” Ms Griffin said. “Savers are often unsure how to use the product, and that uncertainty can lead to poor decisions.

“The withdrawal penalty is also one of the products most pressing problems. It removes the government bonus but also reduces the saver’s own contributions. For those facing unexpected costs or whose house purchase exceeds the price cap, the penalty feels disproportionate and unfair. A simpler system that only recovers the bonus would be far more reasonable.”

Chancellor Rachel Reeves has already intimated a wider ISA reform is on the agenda for later this year, with the Cash ISA limit under consideration amid a plan to encourage investing.