AJ Bell calls for Lifetime ISA rules changes alongside package of ISA reforms to boost investment

AJ Bell is calling on government to strengthen the appeal of the Lifetime ISA as part of a broader package of ISA reforms designed to incentivise investing and boost UK markets.

Responding to the Treasury Committee’s call for evidence on the Lifetime ISA, the business has set out a series of reforms intended to enhance the appeal of the Lifetime ISA, making its purpose clearer and the product easier for consumers to understand and use.

This includes scrapping the punitive early 6.25% encashment charge, removing the age-related restrictions preventing over-40s opening an account, and raising the ceiling on the maximum purchase price limit when using a Lifetime ISA to secure a first home with a mortgage.

These measures should be implemented alongside broader reform of ISAs to radically simplify the system and remove barriers between cash saving and investment.

Merging Cash ISAs and Stocks and shares ISAs into a single tax wrapper offers a relatively simple measure, with zero additional cost to the Treasury, which would encourage retail investment in UK assets without minimising choice available to savers and investors.

The Lifetime ISA needs a revamp and there are some obvious measures that would make the product work more effectively for consumers. However, this must be considered alongside a wider package of ISA reforms to ensure a joined-up approach to designing the ISA system of the future. A piecemeal strategy has led us to a place where we have too many ISA products, too many rules and too much complexity. Simplification must be the over-arching focus of any government reforms, starting with merging Cash and Stocks and shares ISAs.

There is no doubt that the Lifetime ISA has proved to be a bit of a marmite product. For prospective first-time buyers it can offer a massive leg-up onto the property ladder. It is impossible to imagine the government scrapping it altogether. The optics of withdrawing support for renters hoping to purchase their first home would eventually mean government replacing it with another scheme, introducing confusion and complexity.

Nonetheless, the flaws in its design mean the Lifetimes ISA doesn’t work effectively as a retirement savings product. And it has left some savers angry when they face a government-sanctioned punitive exit penalty if their plans change unexpectedly, and they need to take their money out earlier than planned.

Almost 100,000 people made unauthorised withdrawals from Lifetime ISAs in the tax year 2023/24, with an average value of £3,022. It is clear the early exit charge impacts a lot of people and that they’ve built up reasonable savings pots over a period of time. The 6.25% exit charge is an unfair penalty likely to foster distrust and dissatisfaction if people feel they’re doing the right thing, only to find the government rewards them by pinching a few extra pennies from them when circumstances change beyond their control. Building up a savings pot is largely about securing yourself financially so that you’re in a position to weather a financial storm should it arise. Punishing people at precisely the moment their financial plans change sends out a completely contradictory message.

Likewise, the Lifetime ISA needs to be future-proofed by linking the purchase price limit to house price growth. While most people are able to buy a first home under the current rules, there are some areas in the UK where the average flat or small house is off limits. Over time, this will inevitably extend out across the country until the Lifetime ISA becomes useless for first-time buyers across the UK.

If the Lifetime ISA is retained as a retirement vehicle, then removing age restrictions, a puzzling feature of the product, would also significantly increase its appeal to the self-employed. Tackling the long-term savings challenge for self-employed workers outside auto enrolment is not easy. The Lifetime ISA is a simple way for basic rate taxpayers to save effectively for retirement. Allowing older workers to open an account would ensure that people aren’t frozen out of the system and can commit money to a long-term savings pot when their earnings peak and outgoings like mortgages and education costs come down later in their career.

How should the government reform Lifetime ISAs?

AJ Bell has proposed the following reforms in its submissions to the Treasury Committee’s call for evidence:

• Reducing the early withdrawal charge from 25% to 20% (so it only returns the upfront bonus rather than levying an exit charge equivalent to 6.25% of the account holder’s payments)
• Removing the age restrictions so it can be clearly marketed as a pension alternative for the self-employed
• Increasing the minimum property purchase price to reflect house price inflation, currently set at £450,000
• Making the ISA subscription separate from the Lifetime ISA to simplify the product, enhance understanding, and encourage higher take-up

In addition to these points, it has recommended the Treasury consider how to strengthen the bond between Junior ISAs and Lifetime ISAs, to maximise the number continuing their savings/investment journey. One option would be to allow more than £4,000 (the current annual Lifetime ISA payment limit) to be paid from a Junior ISA on maturity into a Lifetime ISA and still benefit from a bonus.

More broadly, it is critical government doesn’t review the Lifetime ISA in isolation, but rather considers its role as part of a broader review of the ISA ecosystem, aimed at delivering the stated aims of simplification and encouraging greater use of Stocks and shares ISAs.

AJ Bell has campaigned over a number of years for simplification of the ISA landscape to remove complexity and make it easier for people to invest, and has proposed merging Cash and Stocks and shares ISAs a first step to removing barriers between savings and investing.