Rachel Vahey: Why LISA charges should stay at reduced rates

Rachel Vahey explores recent changes to the LISA withdrawal charge structure due to Covid-19 and urges policymakers to make it a permanent alteration for the benefit of savers

As lockdown lingers on, more and more people in the UK are facing financial turmoil created by the Covid-19 outbreak.

Since March there has been a steady stream of HM Revenue & Customs (HMRC) and Department for Work and Pensions announcements, all designed to help people, businesses, and the economy in these times.

HMRC recently announced the charge on Lifetime ISAs (LISAs) will be temporarily reduced from 25% to 20% for withdrawals between 6 March 2020 and 5 April 2021.

LISAs were launched in April 2017, to help those under 40 save for either a first home or retirement. People can save up to £4,000 a year, and the government adds a 25% bonus. Unless the individual is withdrawing the money to buy a house or because they are over 60 (or because of death or terminal illness) there’s a 25% charge which recoups the government bonus plus 6.25% of the member’s subscriptions.

‘Deeply unfair’

I have always felt this charge is deeply unfair. It was presented as a 25% government bonus on the way in, and a 25% charge on the way out. To most people that sounds even. But, of course, it isn’t.

LISA investors losing some of the money they invested simply for withdrawing funds other than in tightly controlled circumstances acts as a disincentive for saving. Reducing the charge to 20% means only recouping the government bonus (plus any growth on that).

For anyone withdrawing funds from a LISA over the next 11 months the charge will simply reduce to 20%. But for those who have already withdrawn funds since 6 March, it’s more complicated.

Most people who have requested a withdrawal since this date will have already received their funds back into their bank account (the LISA provider would have paid the 25% charge).

LISA managers now can claim back the difference between a 25% charge and a 20% charge from HMRC, and credit it back into the investor’s LISA, as long as the LISA is still open.

‘In for a shock’

Those people who were expecting cash in hand from this refund are in for a shock. Instead, if they want the refunded money in their pocket they will have to make another withdrawal equalling the amount of the refunded charge. But this, of course, will be reduced by another 20% charge.

If the LISA was closed when the withdrawal was made then the LISA provider can pay the refunded amount direct to the individual. Of course, this means these individuals won’t suffer a 20% charge on that amount.

Paying the refunded charge back into the LISA is complicated, especially as the client doesn’t immediately get the money in their hand. It would have been far easier for HMRC to refund all clients, either directly or via the LISA provider, regardless of whether the LISA was still open or not.

It is excellent news HMRC is responding quickly to help people. And reducing this charge will help people financially at a time when they really need it. But I hope this change isn’t only a temporary measure. And instead, HMRC changes its stance and makes a 20% charge a permanent feature of LISAs.

Rachel Vahey is senior technical consultant at AJ Bell