Are lifetime ISAs actually any good?

On one hand, it's got issues that even Martin Lewis is complaining about, but on the other, it can be one of the most tax-efficient accounts in the UK… so why aren’t more people interested in the lifetime ISA?

Do they just not understand it? Do they think the negatives outweigh the positives? Or is it simply not as good as some people say?

Let’s dive head first into the world of the LISA. Some things might just surprise you.

And if you have no idea how LISAs work in the first place, we’ve got a full lifetime ISA guide that will help.

Getting stuck in

Let’s cover the basics of how the major UK "tax wrapper" accounts work:

With a LISA, you get a 25% bonus when you deposit, and you pay no tax on withdrawal of profits, but you can only deposit from money that’s already been subject to tax (i.e. your payslip).

With other ISAs, you again pay no tax on withdrawal of profits, and you can only deposit from money that's already been subject to tax. This means LISA contributions are automatically 25% better off than ISA contributions, prior to withdrawals, because maths. 

And with a SIPP, you claim a 20-45% tax rebate when you deposit, but you pay tax on withdrawals – though 25% can be taken tax-free via lump sums. SIPPs also allow you to contribute post-tax (like ISAs) but also pre-tax in many scenarios – and this can make a big difference to how useful they are. We'll examine that in detail shortly. 

To simplify the main perks of the LISA: it has a "free" money element like the SIPP (and other pension products) because you get a government bonus on your contributions, but it also has the tax-free withdrawal benefit that all ISAs offer.

LISA vs ISA

Assuming fees and returns were identical, if you were to deposit the same amount into a LISA or ISA, then withdraw in retirement, a LISA would always be 25% better off.

But there are some crucial things to consider:

Firstly, you can withdraw from an ISA whenever you want. The same isn’t true for a LISA. If you want to withdraw from a LISA, you must wait until you’re 60 years old based on current rules (which are always subject to change), unless you’re using the account to help buy your first house.

If you want to withdraw early from a LISA (i.e. you're not buying your first house or you're under 60 years old), you'll pay an effective penalty of 6.25% on your own savings due to the government's 25% early withdrawal fee.

Example #1 based on an immediate withdrawal: You contribute £800. You get a 25% bonus up to £1,000. You withdraw early and pay a 25% charge on the amount withdrawn. You’re left with £750, which is 6.25% less than you started with.

Example #2 based on saving for five years: You contribute £800. You get a 25% bonus up to £1,000. You generate a 5% annual return for 5 years. Your balance is now worth £1,276.28. You withdraw early and pay a 25% charge on the amount withdrawn. You’re left with £957.21, even though a 5% return on your initial £800 would have been worth £1,021.03.

Some people get a bit funny when you talk about this because of semantics – there is no "official" 6.25% penalty – but the reality is that your end balance is 6.25% lower than your own savings are worth. It’s that blatant of a penalty, even VAR would overrule their mates on it.

But the worst part is that you might end up paying the LISA penalty unintentionally. 

If you want to buy your first home with help from a LISA, the most expensive property you can buy must cost no more than £450,000.

This might be easy to do in many parts of the country, but if you live down south – especially in or near London – a £450,000 property might not meet the minimum living requirements needed if we consider the average age of a first time buyer is someone in their mid 30s, likely with an established family, and unable to get started in a simple one-bed flat.

Buy a house that’s more expensive than the £450k cap with your LISA funds, and you'll be hit with the effective 6.25% penalty.

Interestingly, you'd be better off with a 3.7% interest cash ISA compared to a LISA offering a 25% government top-up and 5% annual interest, but with an effective 6.25% penalty.

Account	Deposit	Interest	Value after 5 years	Penalty	Total
Lifetime ISA	£5,000*	5%	£6,381.41	-£1,595.35	£4,786.06
Cash ISA	£4,000	3.7%	£4,796.82	£0	£4,796.82

And this isn't just a fringe problem, either. When we dug into the government figures, we found that in the last few years, unauthorised LISA withdrawals have actually overtaken withdrawals made for first-home purchases:

LISA vs SIPP

Michael Johnson, who originally proposed the lifetime ISA in 2014, recently stated in evidence to parliament: 

“[For] those who end up paying income tax at the basic rate of 20%, when working and in retirement, a LISA has a 17.6% advantage [compared to a SIPP]... This is an unambiguous fact, not a subjective opinion, pertinent to most people (including 90% of the under-40s).”

This lines up with some calculations we've done on the back of a napkin. We found that if workers stay in the same tax bracket in retirement that they’re in whilst working, a LISA is:

• 17.6% more tax efficient than a SIPP for basic rate taxpayers
• 7.1% more tax efficient than a SIPP for higher rate taxpayers
• 3.8% more tax efficient than a SIPP for additional rate taxpayers

Tax band	£1,000 after tax	LISA deposit*	SIPP deposit*	LISA withdrawal	SIPP withdrawal**	LISA gain
Basic (20%)	£800	£1,000	£1,000	£1,000	£850	17.6%
Higher (40%)	£600	£750	£1,000	£750	£700	7.14%
Additional (45%)	£550	£687.50	£1,000	£687.50	£662.50	3.77%

Because this is a simplified calculation where tax rebates are applied to a SIPP immediately, the LISA performance would actually be larger in reality for higher and additional rate taxpayers compared to what's displayed in the table above. You wouldn't "deposit" the full £1,000 with a SIPP, but your savings would be worth £1,000 after your tax rebate has been claimed. This doesn't affect the basic rate calculation as the full tax rebate is always added into your SIPP as a 20% taxpayer.

However, these calculations have a big flaw.

They’re only accurate if you're comparing contributions to LISAs and SIPPs from your post-tax, post-National Insurance (NI) income.

Whilst many will contribute in this way – especially those that are self-employed – if you’re able to contribute to your SIPP pre-tax, e.g. via a salary sacrifice arrangement, there's big movement in the numbers. Just factoring in reduced NI payments from salary sacrifice can make a LISA and SIPP comparable in tax efficiency. 

Employer matches can also significantly push the numbers further in favour of the SIPP.

Another big flaw in our napkin maths is the assumption that no one moves tax brackets in retirement – in reality, one of the main benefits of a SIPP is the deferral of tax.

Many higher earners would expect to be in a lower tax bracket in retirement. The deferral effectively leads to tax bracket arbitrage – you might get 40-45% in tax rebates as you work and contribute, but only pay 20% in retirement.

Even for those contributing from post-tax income (something the self-employed must do), if you’re in the higher or additional rate tax bracket now but expect to be a basic rate taxpayer in retirement, SIPPs can be the mathematically better option. 

Tax band	£1,000 after tax	LISA deposit*	LISA withdrawal	SIPP deposit*	SIPP withdrawal**	LISA gain
Basic (20%)	£800	£1,000	£1,000	£1,000	£850	17.6%
Higher (40%)	£600	£750	£750	£1,000	£850	-11.8%
Additional (45%)	£550	£687.50	£687.50	£1,000	£850	-19.1%

Like with the first example, the figures for higher and additional rates are distorted due to the way we've simplified the calculations. These figures are still useful as a rough illustration of the point being made, but they shouldn't be used to accurately compare the effectiveness of each account.

The benefits of a SIPP could start to reduce if you expect to have a significant pension pot. Only £268,275 can be taken via 25% tax-free lump sums, so those expecting £1m+ in pension savings could again see things swinging back in favour of the LISA – but it would need to be a big swing (or an extremely large pension pot).

So which is best: LISA or SIPP?

When compared purely as a retirement savings vehicle, on paper, the LISA trumps the ISA every day of the week, assuming you’re contributing the same amount.

However, LISAs only allow for up to £4,000 per year to be deposited (£5,000 in total when factoring in the government’s 25% bonus).

If you decide the LISA is definitely the best option for you but you’re in a position to be putting away more than £333-per-month, you'd max out your LISA annual deposit limit. This means you’d need to use another type of account in addition to your LISA, e.g. a different type of ISA or a SIPP, and that’s fine. 

There’s no rule stating people should only use one type of account. You can use a mix of accounts to tap into the perks of each offering. 

The LISA also trumps the SIPP for those that contribute via their post-tax income – if you expect to stay in the same tax bracket in work and retirement (this is common for 20% basic rate taxpayers).

And if you expect the effects of fiscal drag to continue to force people into paying higher taxes as time goes on (because tax bands are frozen while inflation makes wages rise), more people might be in a higher tax bracket in retirement than they currently think – again slightly favouring the LISA, though this is based on predictions and guesswork, rather than rules. 

However, a SIPP is likely significantly more efficient for those that can deposit via salary sacrifice, access employer matches on their SIPP contributions, or deposit as a company director, or for those that fully expect to be tapping into tax bracket arbitrage.

Your living expenses will often be lower in retirement – especially if you’re a homeowner with a fully paid off mortgage – meaning your income can be lower to support the same standard of living. 

So, which is best? Well, like many things, it depends almost entirely on your own circumstances and goals.

The ISA offers the most flexibility, the LISA offers a nice bonus and tax efficiency for a reasonable number of people, and the SIPP offers greater tax efficiency for another large group. 

Other major talking points

Age limits

One of the biggest downsides of the LISA is that you can only open one before the age of 40, and you can only contribute to one until you're 50.

It should probably be called the "until-you're-middle-aged" ISA rather than the "lifetime" ISA, though we appreciate the branding on UYMAISA isn’t quite as strong. 

If you're still young enough, a sensible idea is to open a LISA and deposit something tiny – even as little as £10. You might never use the account again, but it keeps the option there if you suddenly look down and realise you’re 45 and didn’t act quickly enough.

This realisation sadly happens with many things in life, but at least you might be able to prepare for this one in advance.

Lack of options

Unfortunately, LISAs aren’t exactly popular with providers – our comparison tool lists just eight lifetime stocks and shares ISA options at the time of writing, and even fewer available on the cash ISA side.

This lack of choice means users are unable to get better deals or drive down fees in the same way they can with more traditional ISAs, potentially affecting both savings options and long-term ROIs.

The verdict

Overall, it can be quite confusing trying to compare the numbers between lifetime ISAs and other accounts – especially when trying to weigh up the pros and cons for a wide variety of situations. We spent days researching and writing this, and there’s still nuance we didn't include.

But for some people, there's a pretty clear use case for LISAs: 

• If you’re buying your first home for less than £450,000 in more than twelve months time, LISAs are great
• For self-employed people who expect to be in the same tax bracket during work and retirement, LISAs can be a really good option.

For everyone else, LISAs can fall anywhere on the scale from "potentially useful" to "objectively terrible".

There are campaigns, led by Martin Lewis, to remove the effective 6.25% penalty from LISAs, and to raise the £450,000 limit to at least £600,000 (or scrap it entirely), and it's clear that both of these things are needed. These outdated and ineffective rules were set in 2017, when the average UK house cost nearly £70,000 less than it does today.

These fixes won’t make LISAs more useful to millions of people, but it will make them fairer and better suited to a greater number of users.

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