Government to Scrap Lifetime ISA Exit Penalty During First Year

The government has announced that for the first year after its introduction, Lifetime ISA holders will not be liable to pay the controversial exit fees if they choose to withdraw their funds early.

The Lifetime ISA will be available from April 2017, and will offer account holders a government-backed bonus of 25% each year on deposits of up to £4,000. The only condition is that the money be used either to pay for a deposit on a home (similar to Help to Buy), or as post-retirement income (accessible after the account holder turns 60).

It was announced earlier this year that LISA holders would face a hefty penalty if they withdrew the money early for any purpose other than the two stated. Those who do so would have to sacrifice 25% of their total LISA balance - meaning that they would lose more than they had been given as a bonus in the first place. For example, if someone does deposit the full £4,000 each year for three years, the total balance (with the 25% annual bonus) would be £15,000 ((£4,000 + £1,000) X 3), not accounting for interest earned. If this was withdrawn early, they would have to pay 25% of that as a penalty, totalling £3,750, while the total value of their government bonus would have been just £3,000. Following this announcement, the FCA proposed that LISA providers must warn those looking to set one up about the risk of losing out on their investment should they decide to withdraw their fund early.

Earlier this week, Treasury secretary Jane Ellison explained that for the first financial year of the LISA’s availability (2017-18), the 25% penalty charge would not apply. However, rather than being a response to any criticism, this is solely because of the logistics of when the government bonus would actually be paid during the first year.

Ultimately, the bonus is due to be paid monthly, however this will only be the case after April 2018. Bonuses due to those who set up a LISA during the 2017-18 tax year will be paid in a single lump sum at the end of that year.

If the penalty fee was still payable during the first year, Ellison explained, it “could create a difficult case where people face a 25% government charge up to 12 months before they receive the bonus”.

Former pensions minister Steve Webb criticised Ellison’s announcement as yet another sign that “the Lifetime ISA has not been properly thought through”.

He said: “The new product, which is a complex hybrid between a pension and an Isa, is due to be implemented in just a few months, and yet the government is still making up the rules as it goes along.

“It is not too late for the government to admit that the Lisa risks undermining the real progress made on getting young people saving through a workplace pension under automatic enrolment, and to reconsider the whole project.”