HMRC has collected millions of pounds in withdrawal penalties on Lifetime ISA accounts since 2018, with the total reaching around £56 million. The accounts are designed to help savers put money aside for a first home or retirement, offering a 25% government bonus each year up to a maximum of £1,000. However, a matching 25% penalty applies to withdrawals that do not meet the government's criteria, and many savers do not realise the charge can eat into their own contributions as well as the bonus.
How the 25% penalty works
Lifetime ISAs, or LISAs, are tax-free savings accounts that allow savers to deposit up to £4,000 per year and receive a 25% government-backed bonus worth up to £1,000. The penalty for withdrawals that do not meet the criteria is also 25%, but few savers realise this claws back more than just the bonus.
UK property-market specialists at Sylvest explained that if a saver puts aside the maximum £4,000 in a year, they will get a 25% bonus of £1,000, making their total savings £5,000. If they then withdraw this amount for an unsanctioned reason, the penalty is 25% of the £5,000, which is £1,250. This means the penalty has also taken £250 of the saver's own contributions.
House price threshold unchanged since 2017
Savers wanting to use a Lifetime ISA to buy their first home must meet a range of criteria to avoid the penalty, including only buying properties worth £450,000 or less and using a conveyancer or solicitor. Despite rising house prices, the £450,000 threshold has not changed since 2017, leaving some first-time buyers forced to take the penalty even if they meet all the other withdrawal rules.
The government is now working on a potential alternative for first-time buyers after admitting earlier this year that the Lifetime ISA might not be working for everybody. A Treasury spokesman responded: “We recognise that the Lifetime ISA is not working for everyone, particularly when people’s circumstances change. That is why we are consulting on a new and improved product, specifically designed to support first-time buyers and without penalty for withdrawals.”
Impact on savers and next steps
The consultation on a new product signals a potential shift in policy, but until any changes are implemented, current Lifetime ISA holders remain subject to the existing rules. Savers who are considering withdrawing funds for reasons other than buying a first home or retirement should be aware that the 25% penalty may exceed the bonus they received, resulting in a net loss on their own deposits.
HMRC's collection of around £56 million in penalties since 2018 highlights the scale of withdrawals that have fallen outside the permitted criteria. The outcome of the government's consultation will determine whether first-time buyers will eventually have access to a more flexible product without withdrawal penalties.
