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Not enough people in the UK are on track with saving for their first home and retirement. Can the Lifetime ISA – with its 25% government bonus – change the way young people save?

The government launched the Lifetime ISA in April 2017, with the aim to help young people save for the future.

It’s open to UK residents aged between 18 and 39, and the government will contribute an annual bonus equivalent to 25% of each person’s contributions during that year. This tax-efficient account is designed to be used for the deposit on a first house or to supplement retirement income.

State of the nation’s young adults

Whether you know them as Generation Y or the millennials, they’re those born between the 1980s and the mid-1990s who are currently around 35 or younger. This group is particularly likely to be financially vulnerable, as many of them emerged into financial independence during the most recent recession.

On top of trying to find work in a struggling jobs market, many young people in the UK have been hit by a number of factors that make it harder than ever to put money aside for their futures.

For example, high living costs are a major burden on many. Tenants around the UK typically spend more than a quarter of their gross salary on rent, with tenants in London spending almost half their salary on rent.

With large sums of people’s money therefore being swallowed by high rents, putting money aside for big life events like buying a house or retirement is increasingly difficult.

In fact, a YouGov report published in May 2017, which surveyed around 2,000 British adults, suggests that 44% of those aged between 18 and 34 have no pension provision at all.

Although the recent requirement for employers to provide and contribute to a pension for their employees will help people have some pension, it may not be enough. So, having another way to help people put money aside, like the Lifetime ISA, is good news.

Will the Lifetime ISA help?

The Lifetime ISA is specifically designed with millennials in mind: you have to be under 40 to open an account. A report by the Institute for Public Policy Research, published in 2011, recommended the introduction of a new life-course savings account that matched savers’ contributions up to a certain level. The report suggested that this type of account would improve the financial resilience of young people.

The 25% government bonus should be a massive incentive to help young people set some money aside – it’s essentially free money, after all. And the total balance can grow tax-free, including the individual’s contribution and the government bonus.

However, the Lifetime ISA is not as flexible as other ISAs. You can access the money at any time, but if you withdraw before you’re 60, and do not use the money to buy a house costing less than £450,000 or because you’re terminally ill, you will lose out. You’ll have to pay a 25% government withdrawal charge (the withdrawal penalty will be temporarily reduced from 25% to 20% from 6 March 2020 till 5 April 2021 due to coronavirus) meaning you’ll get back less than you’ve put in.

The verdict?

The Lifetime ISA could make buying a first home seem like a more realistic proposition. And, with the flexibility to continue saving into the ISA after withdrawing some or all of the money to buy a house, people should find it easier to supplement their retirement income. Those with a Lifetime ISA continue receiving the 25% government bonus until their 50th birthday and the money is available tax-free on reaching 60.

See what you could get

Nutmeg offers a stocks and shares Lifetime ISA. Use the Nutmeg Lifetime ISA calculator to see how much you could need to invest with a stocks and shares Lifetime ISA.

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest.

A stocks and shares Lifetime ISA may not be right for everyone. You must be 18–39 years old to open one. If you need to withdraw the money before you’re 60, and it’s not for the purchase of a first home up to £450,000, or a terminal illness, you’ll pay a 25% government penalty. (The withdrawal penalty will be temporarily reduced from 25% to 20% from 6 March 2020 till 5 April 2021 due to coronavirus). So you may get back less than you put in.

Compared to a pension, the Lifetime ISA is treated differently for tax purposes. You may be better off contributing to a pension.

If you choose to opt out of your workplace pension to pay into a Lifetime ISA, you may lose the benefits of the employer-matched contributions.

If you are unsure if a Lifetime ISA is the right choice for you, please seek financial advice.