LISA0131

Written evidence submitted by Dr Ekaterina P. Damianova [1]

1. Introduction and rationale to submit the evidence

As an assistant professor in Durham University, a leading educational institution, I teach and contribute to the development of a large number of young adults about to embark on their careers, and make retirement and real estate decisions, including participating in the LISA scheme. As such, I believe it crucial to evaluate the programme using available data on its use and its pros and cons compared to the alternatives. My research interests also fall in the area of real estate and personal investment.

2. Background

The Lifetime Individual Savings Account (LISA) was introduced in April 2017 to help individuals aged 18-39 buy their first home and save for retirement. It allows savers to receive a government bonus of 25% contribute on contributions up to £4,000 per year, until they turn 50. Savers are authorised to withdraw from a LISA without a penalty when they purchase their first home worth up to £450,000, when they turn 60, or when they become terminally ill (Lifetime ISA). Withdrawals for other purposes are not authorised and carry a 25% penalty, effectively reclaiming the government bonus and 6.25% of the savings (for each £1 contributed, when accounting for the bonus and the penalty, but not for the capital gain or loss, the saver can withdraw £1.25 X 0.75 = £0.9375 without an authorisation).

The LISA savings account has been growing in popularity. In the 2016-17 fiscal year (the year of its inception), around 154,000 new accounts were subscribed with total deposits of around £486 million. The number of subscriptions has steadily increased over time and for the 2022/23 fiscal year, around 755,000 new accounts were subscribed with total deposits exceeding £2 billion (HMRC Annual Savings Statistics, Individual Savings Accounts).

Subscribers have also started withdrawing funds for buying their first home. In the 2023-24 fiscal year, around 56,900 individuals have withdrawn funds to buy their first home, withdrawing a total amount of around £850 million. Along with the authorised withdrawals, unauthorised withdrawals have also increased. For the same period, around 162,000 individuals have withdrawn an average of around £1860 per account incurring total penalties of more than £75 million. All these individuals would have fared better with a different type of a savings account (e.g., cash or stocks and shares Individual Savings Account).

These unauthorised withdrawals, and other features of the programme (such as the size of the penalty, the home value upper limit of £450,000, the complexity of the scheme and its overlap with other incentive schemes) have called into question the viability of the LISA scheme, the optimality of its provisions, and lead to the current call for evidence by the Treasury committee (HMRC Annual Savings Statistics, Individual Savings Accounts).

3. Comparison to other tax-saving schemes

The LISA scheme is the only scheme that serves the dual purpose of providing tax incentives for individuals to save for retirement and to buy their first home. The overlapping programmes that target the individual objectives (either buying a home or saving for retirement) are presented in Figure 1.

Figure 1. Tax efficient ways to buy a home and save for retirement

3.1 Saving for retirement: Lifetime ISA vs cash/stock and shares ISA

The Cash/stock and shares ISA has an annual contribution limit of £20,000, provides no government subsidy, but allows for withdrawals without a penalty. Both schemes ensure the tax-free growth of capital (Individual Savings Accounts, ISAs). The government subsidy of the LISA is counterbalanced by the limited liquidity for account holders. Investors can invest in both schemes at the same time and strike a balance between liquidity needs and government subsidy. Any savings over £4,000 will not include a government subsidy and would thus be better invested in an ISA to avoid liquidity constraints.

3.2 Saving for retirement: Lifetime ISA vs Pension schemes

Pension schemes such as workplace-pension schemes, salary sacrifice arrangements, or private pension savings (i.e., investment in self-invested personal pension or SIPP) allow contributors to save on income tax and national insurance (Personal Pensions). Contributions to these schemes reduce the current taxable income of savers. Income tax is paid in retirement when pensioners start to draw from these funds. For most individuals the income and the marginal tax rate are expected to be lower when they retire and therefore savings in a pension fund has tangible tax benefits. The attractiveness of the Lifetime ISA relative to these pension schemes, can be calculated under different scenarios and personal circumstances. Looking at purely income tax effects, a 40% income tax marginal taxpayer (individuals earning a gross income exceeding £50,270 for the 2024/25 tax year, Income Rates and Personal Allowances), who subsequently withdraws the savings when their income is lower and at the 20% income tax margin, for each £0.6 saved in a pension, the saver will be able to withdraw £0.8. Ignoring capital gains, this represents tax savings of 0.8/0.6-1=33.3%. From that perspective, the private pension is more attractive, given that private pension funds are accessible at 55 (57 from April 2028) which is below the relevant age of 60 for the LISA. A similar calculation reveals that a 20% marginal taxpayer would find the two options equally attractive if they can draw income tax free once they reach the age of 60. However, given the stagnant income tax brackets, capital gains, and the potential receipt of state pension would imply that this situation applies only to a minority of savers. For the 20% marginal taxpayer, who would then withdraw at 20% marginal tax rate it would be optimal to contribute to a LISA up to the currently matched maximum of £4,000 a year.

In sum, the LISA is a tax efficient way to save relative to a pension only for individuals with a marginal tax rate of 20% or less. These are most likely individuals early on in their career. The optionality of the LISA to withdraw funds for buying a home adds additional value and early liquidity relative to pension savings.

3.3 Buying a home: Lifetime ISA vs Help to Buy ISA

The Help to Buy ISA is a scheme offering a subsidy exclusively for the purpose of purchasing a first home, which is now not open to new members. Similarly to the LISA, it offers a 25% tax free bonus but has a maximum contribution of only £2,400 per year. It has no penalty for withdrawals but a lower limit on property values outside London (£250,0000). Notably, savers can use only one of the schemes for the purpose of buying a home. The Help to Buy ISA, however, is phased out with the introduction of the LISA. It was closed to new applicants on 30 November 2019; existing account holders can make contributions until 30 November 2029 and claim the 25% bonus on savings by 1 December 2030 (Help to Buy ISA)

4. The LISA: a product with embedded real options

The LISA is a product with multiple embedded options: the option to expand (making additional contributions of up to £4,000 each year), the option to wait allowing account holders to start saving when they can afford it and buy a home when they have saved enough for a deposit, the option to adjust the investments in their portfolio (between cash and stock investments), the option to exit their investment, albeit with a penalty, and most notably the option to use it for two distinct purposes: home buying and retirement savings. For an overview of various types of real options and recent developments of option theory in finance see, e.g. Ragozzino et al. (2016).

With respect to Home Buying, the LISA can be used together with various affordability schemes enabling account holders to get onto the property ladder, such as Shared Ownership, Rent to Buy or Right to Buy, effectively facilitating and accelerating the attainment of home ownership (Conveyancers: Lifetime ISA technical guidance). The product has the potential to slow down, if not reverse the trend of increasing average age of first-time buyers, which currently stands at 34 for England (English Housing Survey 2023 to 2024).  While the other schemes reviewed also entail embedded options, the LISA allows for a versatility around the most important financial decisions in the lifetime of a family. Equipped with these preliminary considerations, I turn to the relevant questions.

5. Questions and Answers

Q1. Is the Lifetime ISA fit for purpose in its current design, including as a combined product for house purchase and pension saving?

The number of LISA accounts has increased from 154,000 in 2017-2018 to 755,000 in 2022-23, an almost fivefold increase. For the same period, Cash ISAs have increased from about 7 to 7.86 million and the Stock and Shares ISAs from around 2.9 to 3.8 million (HMRC Annual Savings Statistics, Individual Savings Account Tables). The rapid growth in subscriptions shows not only that the product is becoming more popular with households, but also that lenders are offering this product. While none of the account holders have currently reached retirement age, the number of withdrawals has steadily increased. For the 2023/24 fiscal year, 56,900 individuals have used their accounts to buy a house, withdrawing an average of £14,927. This amount is close to the 5% required deposit for a property of average value, currently around £290,000 (UK House Price Index, November 2024). This shows that the scheme is serving its intended purpose with respect to homeownership.

Q2. How well do consumers transition between using the Lifetime ISA as a product for house purchase, to then a product for pension saving?

Currently published government statistics do not provide information on how individuals save. One way to gain insights is to survey homeowners with LISA accounts.

Q3. Given its policy purposes, is the Lifetime ISA value for money for the Government?

For the 2023/24 fiscal year, the total value of house purchase withdrawals amounted to around £849 million. If roughly 25% of this amount was a government subsidy (ignoring capital appreciation), this would amount to a subsidy of around £212 million. The total value of withdrawal charges was around £75 million, so that in effect the effective cost for the government was about 137 million for a total of 56,900 houses purchased, which amounts to a rough figure of an average subsidy of £2,400 per individual buying a house. This appears to be a modest contribution relative to grants for shared ownership and affordable housing such as the Affordable Homes Programme with a budget of around £11.5 billion for the construction of up to 180,000 new homes (amounting to an average subsidy of about £64,000 per home).

A more in-depth analysis could be conducted to assess the additionality of the LISA scheme, which would estimate how many houses would not have been built without the LISA policy, and whether and when account holders would have achieved homeownership if this account did not exist.

Q4. Is the Lifetime ISA a suitable pension savings product?

There is currently insufficient data to assess savings behaviour for the purpose of retirement. The comparison to pension schemes reveals that the LISA is preferrable only for savers with a 20% marginal tax rate who will draw an income in retirement below the £12,570 threshold. When used solely for retirement purposes, the LISA is unlikely to appeal to many households. However, its embedded optionality would appeal to households who saved for a house but ended up living in another arrangement (e.g. social housing). For this group, the LiSA is a mechanism to encourage savings which otherwise would not be possible.

Q5. Should the Lifetime ISA be abolished?

LISA offers unique features and creates incentives to encourage savings behaviour which cannot be attained by a combination of other products. The uptake of the programme is promising as the programme has increased over time. In sum, the programme should not be abolished. 

Q6. Should the Lifetime ISA be reformed to remove the withdrawal penalty?

The withdrawal penalty is intended to incentivise savings and a better management of lifetime financial wealth. It also reduces the cost for the Government as it helps the Treasury recover some of the subsidy. The LISA can also be used in conjunction with a Cash or Stock and Shares ISA. Households who need a liquidity buffer can open both accounts and maintain a buffer in the cash/stock and shares ISA. The average value of unauthorised withdrawals has stabilised at around £2,000 in 2023 and 2024 which might be an indication that households are better able to manage their liquidity needs and manage liquidity shocks.

Q7. Should the Lifetime ISA be restricted to those with no access to a workplace pension?

The LISA is not attractive to most individuals with a workplace pension, and one would assume that these individuals will not choose the LISA in lieu of salary sacrifice in their pension. This, however, is an empirical question and the analysis of household-level data would shed further light on that question.

Q8. Should the Lifetime ISA house price cap be raised in line with inflation, or removed?

The answer to this question would depend on the type of demographic the scheme is intended to support. It appears reasonable to update the price cap in line with inflation following specific rules as the ones used to index the state pension. 

Q9. Should the annual Lifetime ISA limit be raised from £4,000?

The current limit means that households need about three years of full contributions, plus the subsidy to save for a 5% deposit on an average value home (around £15,000). As house prices grow, the limit should also be raised to ensure that the savings for a deposit can be generated within about the same time frame.

Q10. Should the Lifetime ISA be reformed in any other way?

The LISA might prove suboptimal for individuals who saved with the intention of buying a home but eventually lost eligibility (e.g., inherited a home or part of a home) or decided not to buy (e.g. as they qualified for social housing). The LISA for these individuals presents a significant liquidity constraint as the funds are accessible only from the age of 60+. Aligning the age limit for withdrawals with the eligible age for pension withdrawals (57 from April 2028) would benefit these individuals without compromising the viability of the scheme.

6. Conclusion

The LISA is a unique product offering savers a substantial flexibility in savings to purchase their first home and for retirement. Its structure creates incentives for individuals to save and manage their lifetime wealth to attain the goals of homeownership and adequate savings for retirement. According to data since the inception of the programme in 2017, the uptake of the programme has been encouraging and so has been the use of these accounts for house purchases. There is, however, currently no data on how individuals use these accounts to save for retirement. Furthermore, it is unclear how households who have not purchased a home fare in the programme. Potential programme reforms to alleviate a liquidity problem for individuals in their 50s is to align the authorised age of withdrawals with that of private pensions.

January 2025

References

Conveyancers: Lifetime ISA technical guidance. Available at: https://www.gov.uk/government/publications/conveyancers-lifetime-isa-technical-guidance/conveyancers-lifetime-isa-technical-guidance#:~:text=A%20Lifetime%20ISA%20investor%20can%20purchase%20a%20shared%20ownership%20property,than%20the%20initial%20share%20purchased.

English Housing Survey 2023 to 2024. Published by the Ministry for Housing, Communities and Local Government. Accredited official statistics. Chapter 3: Housing history and future of housing. Available at: https://www.gov.uk/government/statistics/chapters-for-english-housing-survey-2023-to-2024-headline-findings-on-demographics-and-household-resilience/chapter-3-housing-history-and-future-housing#:~:text=In%20London%2C%20the%20average%20age,20%20when%20it%20was%2032.

Help to Buy ISA. Available at: https://www.gov.uk/help-to-buy-isa

HMRC Annual Savings Statistics. Individual Savings Account Tables 2024. Last updated 4 December 2024. Available at  https://www.gov.uk/government/statistics/annual-savings-statistics-2024

HMRC Annual Savings Statistics. Lifetime Individual Savings Account Tables 2024. Last updated 4 December 2024. Available at https://www.gov.uk/government/statistics/annual-savings-statistics-2024

Lifetime ISA. Available at

https://www.gov.uk/lifetime-isa

Income Rates and Personal Allowances. Available at: https://www.gov.uk/income-tax-rates

Individual Savings Accounts, (ISAs). Available at https://www.gov.uk/individual-savings-accounts

Personal pensions. Available at:

https://www.gov.uk/personal-pensions-your-rights

Ragozzino, R., Reuer, J.J., and L. Trigeorgis. (2016). “Real Options Strategy and Finance: Current Gaps and Future Linkages.” Academy of Management Perspectives, 30 (4), 428-440.

UK House Price Index. Available at: https://landregistry.data.gov.uk/app/ukhpi/