These days, there are a number of different ways to get your foot onto the property ladder. And since their launch in 2017, lifetime ISAs (LISAs) have become one of the most popular ways to do so. The house price boom of recent years has contributed to wider than ever usage of LISAs, according to a report from Hargreaves Lansdown. But for all LISAs can be helpful, it’s important to know how they work. Here, I look into three lifetime ISA mistakes that could leave you worse off than you started.
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1. Not understanding how the withdrawal penalty works
Using a lifetime ISA is a great way to save tax-free for your first home or to fund retirement. And on top of that, the government will reward your effort with a 25% bonus worth up to £1,000 a year.
It all sounds great, right? The catch is that if you need the money for anything other than funding your retirement or paying for a first home, you’ll have to pay back the government a penalty fee of 25% of the balance of your account.
You might think this equates to simply paying back the bonus the government has given you. Well, think again. This is actually one of the worst lifetime ISA mistakes that people make. Let’s assume that you have maxed out your £4,000 annual LISA allowance and claimed the £1,000 government bonus. This takes your account balance to £5,000. If you want to withdraw the £5,000, you’ll have to give the government 25% of the total, or £1,250, which will leave you with £3,750, not the £4,000 you originally deposited.
So, make no mistake, this lifetime ISA blunder could cost you more than you initially thought.
2. Not reading the small print
Let’s assume that you’re planning to use your LISA towards buying your first home. You haven’t been able to save for very long, but you’ve managed to max out the annual allowance and put £4,000 into the account in a matter of months. This takes you one step closer to your dream of owning a property. However, if you overlook the small print that comes with all LISAs, you might find you can’t access the government bonus you were counting on.
The small print stipulates that you have to have contributed for 12 months before you can access your money with the bonus for your first home. You can’t just deposit £4,000 at the beginning of the financial year and then withdraw it all (including the bonus) a few months later. So, if you plan to use a LISA to save for your first home, make sure you are not planning to buy in the 12 months after opening your account.
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3. Using your LISA to invest in the stock market
Did you know that you can use your lifetime ISA to invest in the stock market? That’s right, you can use it in the same way as you would a stocks and shares ISA.
A key aspect to consider, however, is whether you can afford for your money to be invested in the market for more than five years. If the answer is no, then a stock and shares LISA might not be suitable for you. This is because investing in the stock market should be considered a long-term endeavour. As that will allow you to ride out any stock market volatility.
For example, the early days of the Covid-19 pandemic were characterised by extreme uncertainty that led to a frantic market selloff. And if you were to withdraw your money at that time (for example, because you found a house that you want to buy), then you could end up getting back less than you initially deposited because the markets were down.
Avoid the pitfalls of this lifetime ISA mistake by considering whether you can afford to invest your LISA five or more years.
Get the most out of your LISA
Don’t get caught out by the 12-month rule. If you want to access your money and collect the government bonus, you have to contribute to your LISA for at least 12 months.
To max out your LISA allowance (£4,000), you will need to put away at least £333 a month.
Only get a stocks and shares LISA if you plan to invest for more than five years. This way you can ride out any market volatility.
Don’t put all your savings for a house into a LISA. Keep some in an easy access savings account so that it’s accessible for expenses like conveyancing and legal fees.
The post 3 lifetime ISA mistakes that you can not afford to make appeared first on The Motley Fool UK.
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