Lifetime ISAs could lead to consumers making poor investment decisions, a damning report from the Treasury Committee has found.
The inquiry into whether the product is still fit for purpose eight years after its launch found the dual nature of the product increases the risk of savers choosing unsuitable investment strategies and makes it complex to navigate.
The report identified confusion around the withdrawal charge and found LISA holders risk losing a significant part of their savings due to withdrawals to cover unforeseen circumstances.
It also found that cash LISAs may not be the best way to save for retirement and may divert people from saving in more efficient pensions.
The LISA was launched in April 2017 by then-Chancellor of the Exchequer George Osborne as a way to help people save for their first home and help people save for retirement. Since then, eligible individuals have been able to open a LISA and save up to £4,000 in the account each tax year. The Government provides a 25% bonus on such contributions per tax year.
Savers can make LISA contributions and receive a bonus from the age of 18 up to the age of 50, but they must have opened their LISA before they turn 40.
However, the report found that only 33 (one in seven) of all ISA providers have chosen to provide the LISA due to its complexity. Others cited the dual purpose of the product as creating “unnecessary complexity.”
Meanwhile, only around 6% of the population who have ever been eligible for a LISA have held one. Among those aware of the product, many chose not to open one citing the need for accessible savings in case of emergency.
Tom Selby, director of public policy at AJ Bell, said: “The Lifetime ISA is a fantastic savings and investment product when used correctly, but there’s no question that there are several design flaws which need to be ironed out.
“The Treasury Committee report provides further impetus behind the Government’s plans to reform the ISA market, with the aim of ensuring the UK’s labyrinthine ISA system works better for consumers and boosting long-term investing in the process.”
AJ Bell has long campaigned for an end to the early withdrawal penalty on Lifetime ISAs, pointing out that reverting to the system used during the pandemic when the penalty only matched the original bonus received on the account would be a “fairer approach.”
HM Treasury has collected around £213 million in withdrawal charges from approximately 286,000 individuals due to unauthorised withdrawals over the six tax years to 2023-24. In the 2023-24 financial year alone, £75 million was paid in withdrawal charges, a 39% increase on the previous year.
Sarah Coles, head of personal finance at Hargreaves Lansdown, said: “The flexibility people have to withdraw money from a LISA in an emergency is a key feature of the product. It’s what persuades some reluctant people to put money aside for the long term. However, the penalty means giving up a chunk of their own money, which is clearly unfair – penalising people for trying to do the right thing. It’s why we want to see the penalty reduced to 20%, which effectively just removes the Government bonus.”
Similarly, experts said raising the property purchase price limit would be helpful for first-time buyers.
Analysis by AJ Bell showed that in numerous areas, average flats and terraced houses now exceed the £450,000 cap.
Selby said: “ISAs are incredibly popular but political tinkering means a patchwork quilt of products has been stitched together over time; the fact we have the Lifetime ISA at the same time as still having Help to Buy ISAs in circulation, illustrates how complex the landscape has become.
“Research supported by AJ Bell shows that when faced with excess complexity, people often choose the path of least resistance in the form of cash saving. As the Treasury Committee report points out, the binary nature of cash and stocks and shares Lifetime ISAs exacerbates the danger people end up saving in cash when they could be better served investing, especially when using the account to fund retirement.”
Selby said removing complexity could play a crucial role in breaking down the psychological and material barriers between saving and investing.
He added: “Simplifying the ISA landscape, including the Lifetime ISA, would make it easier for people to identify the right product for their needs and put an end to what many consumers see as an either/or choice between cash savings and investments.”
Rachael Griffin, tax and financial planning expert at Quilter, said the report should be the “catalyst for serious reform.”
“The Lifetime ISA does not sit comfortably within the wider savings system and trying to make it serve two purposes has only added to the confusion. There is a clear opportunity to replace it with simpler, more targeted tools that give people the right support whether they are saving for a home or planning for later life. This should be a major focus of Labour’s upcoming ISA simplification programme this summer.”
However, the report highlighted a positive use case of the LISA as a retirement savings product for self-employed people.
According to research from Hargreaves Lansdown, only 21% of self-employed households are on track for a moderate income, compared to 36% of households overall.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “It’s a pressing issue that needs to be resolved and the LISA just might help us close the gap. The 25% bonus on a LISA acts in the same ways as basic rate tax relief on a pension and the money can be accessed if needed subject to a penalty. Added to this any income can be taken tax free.
“The report says that the LISA seems to work well with the self-employed and with further tweaks it could help further. We have long argued that if the penalty could be reduced from 25% to 20%, this could act as a further incentive for the self-employed to get a LISA, as they know they would not be losing a chunk of their own money in the event of early access.”
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