ISA vs LISA: what’s the difference and which is the best option for you?

What is an ISA?

An ISA, standing for “individual savings account”, is a popular type of account for UK residents to save or invest their money.

ISAs are favoured for their tax-efficient status, as any interest or investment returns they generate are Income Tax-free and Capital Gains Tax-free.

It’s important to note that ISAs are generally considered to be “tax-efficient” rather than entirely “tax-free”, as they can be included in the value of your estate and therefore subject to Inheritance Tax (IHT).

This tax efficiency is also sometimes mistaken for tax relief. However, tax relief works differently, essentially returning some of the tax you’ve paid, rather than not charging it.

ISAs do not receive tax relief in this way.

The annual ISA allowance

As ISAs come with such attractive tax benefits, the government puts a limit on how much individuals can save or invest in them in a single tax year. This limit is known as the “ISA allowance”.

This ISA limit is the maximum an individual can save across the range of ISAs. So for example, if you saved £5,000 in one ISA and £3,000 in another in one tax year, you’d have used up £8,000 of your total allowance.

In the 2021/22 tax year, the total allowance stands at £20,000. This limit resets at the start of each tax year on 6 April. If you don’t make use of your entire allowance before then, you’ll lose any remaining amount.

What is a Lifetime ISA?

A Lifetime ISA (LISA) is a type of one of these tax-efficient ISA products.

The Lifetime ISA was introduced by the government in 2019 as an account specifically for 18 to 40-year-olds. These accounts have one of two purposes for these savers: to help them buy a first home, or to make a start on their retirement savings.

A maximum of £4,000 a year

LISAs have their own annual limit, allowing you to save a maximum of £4,000 in them in one tax year.

Bear in mind that this £4,000 does count towards your overall ISA allowance in a single tax year. So, if you use the full amount in a LISA, you’ll only be able to save or invest £16,000 in other ISAs.

A 25% bonus from the government

Crucially, a notable benefit of a LISA is that a 25% government bonus is paid on all your contributions.

That means, if you make the maximum £4,000 subscription to your LISA in a single tax year, the maximum bonus you can receive is up to £1,000 per year.

Typically, any government bonus paid is calculated and added on a monthly basis after you make your contribution to the account. Some providers may pay it at the end of the tax year.

This bonus can make a huge difference to your LISA savings.

The Lifetime ISA withdrawal charge

A downside of a Lifetime ISA is that you’ll face a hefty withdrawal charge if you withdraw money without using it to buy a home or before you turn age 60.

Your withdrawal will be charged a 25% fee, removing any bonus plus a bit extra.

So, for example, if you had made one full years’ worth of contributions of £4,000 and received the £1,000 bonus, you’d have £5,000 in your account. If you then decided to withdraw this entire amount, you’d lose 25% of the value, a total of £1,250 on your withdrawal.

That means, even though you put in £4,000, you’d only get £3,750 back. Make sure you’re aware of this and plan accordingly so you don’t unnecessarily lose money to withdrawal charges.

Benefits of a Lifetime ISA

Save or invest through a LISA

Depending on the product you choose, you can save or invest through either a Cash LISA or a Stocks and Shares LISA.

In a Cash LISA, your money is held out of the stock market, receiving interest alongside the government bonus.

In a Stocks and Shares LISA, you can buy and sell investments with the money in the account. This gives you the chance to target returns for the funds you want to use to save for a first home or retirement. Bear in mind that investing your LISA holdings also means there’s a risk of losing money on them.

As with any other kind of ISA, interest and returns generated in Lifetime ISAs are Income Tax-free and Capital Gains Tax-free.

If you want to open a Lifetime ISA and you’re not sure which provider is best for you, check out my list of the Best Lifetime ISAs for UK savers here.

You are also able to transfer money in an existing LISA to another provider if one on this list looks preferable to you.

Make sure any ISA provider you choose is authorised and regulated by the Financial Conduct Authority (FCA).

Buying your first home

As one of the designated purposes of a LISA is that you can use it to buy your first home, that means a LISA could be a great option for you if you’re a first-time buyer.

When they were introduced, LISAs superseded the Help-to-Buy ISA, an account exclusively designed to help first-time buyers climb the first rung of the property ladder.

In a Help-to-Buy ISA, you can also receive a 25% bonus. However, these products come with a maximum monthly contribution limit of £200 (£2,400 a year) and you can only claim the bonus up to an account value of £12,000. That means the maximum bonus is £3,000.

Meanwhile, Lifetime ISAs allow you to pay in and receive a bonus up to age 50. That means, if you paid the maximum account into the account each year from age 18 to age 50, you’d receive £33,000 in bonus.

You can also only use a Help-to-Buy ISA to buy a property worth:

• Up to £250,000 outside of London
• Up to £450,000 in London

LISAs do have a similar limit on the maximum price of a property you can use one on, but it is fixed at £450,000 no matter where you buy your property geographically.

You have not been able to open a new Help-to-Buy ISA since 2019. You can continue paying into one you already had, and you could transfer it to a LISA.

Saving for retirement

Saving into a LISA for retirement can be a great way to build a pot of savings for later life.

You can open your LISA between the ages of 18 and 40, and make payments into the account up until age 50. Once you turn age 50, you’ll no longer be able to pay money into your LISA.

That means, if you made the maximum £4,000 contribution to your LISA every tax year while you can, you’d save £132,000 into your LISA.

You’d then receive £33,000 of government bonus, giving you a total of £165,000 in your account – and that’s without any interest or investment returns your money would generate, depending on which kind of LISA you have.

Once you turn age 60, you’ll be able to access your funds and use them as you wish.

Other types of ISA

If you think that a Lifetime ISA may not be quite the right product for you, you may want to consider one of the other available ISAs. Below are just three of the ones that may offer what you need.

Cash ISA

Similarly to a regular savings account, Cash ISAs allow you to hold your money in cash away from the stock market in return for interest payments from a provider.

It may be worth shopping around to find the account with the best interest rate.

Stocks and Shares ISA

You can invest in a range of assets through a Stocks and Shares ISA, including stocks, shares, bonds, funds, and even investment trusts.

All returns are Capital Gains Tax-free.

Innovative Finance ISA

Innovative Finance ISAs allow you to lend your money to individuals and businesses in return for interest.

Bear in mind that these accounts come with a greater amount of risk. They are typically only suitable for experienced or institutional investors who are comfortable with the risk of losing money on their investment.

Frequently asked questions

Please note

The value of your investments (and any income from them) can go down as well as up and you may get back less than you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.