Lifetime Isa penalties too complex for even 'financially literate' savers to grasp

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Early Lifetime Isa withdrawal penalties are too complicated, a government report suggests, with even clued-up savers losing out due to a lack of understanding.

HMRC found that even those classed 'highly financially literate' often 'overlooked the fact the withdrawal charge penalises the saver beyond the level of bonus on the amount originally invested.'

The report added: 'Very few Lisa holders in this research understood the withdrawal charge in full.'

For those that were unaware of the full conditions placed on Lisa withdrawal, many viewed the charges as unfair, according to HMRC.

Shaun Moore, tax and financial planning expert at Quilter, said: 'People simply do not realise it's not just a clawback of the Government bonus – it's a loss on their own money.'

Lisas, launched in 2017, allow holders to save or invest up to £4,000 per tax year, on which they will receive a 25 per cent bonus from the Government on contributions up until they reach 50.

Lisa holders face losing some of their own contribution if they withdraw for the wrong reason

Savers can withdraw their funds, along with the bonus, when they purchase their first house, reach the age of 60 or have a terminal illness.

Lisa holders can choose to withdraw their funds from their account without meeting these requirements, but doing so will incur a 25 per cent penalty.

But not only does this knock out the 25 per cent from the Government, it will also eat into the savings the account holder has themselves contributed.

For example, a Lisa containing £800 as well as a £200 contribution from the Government would face a charge of £250 for an unauthorised withdrawal.

This means that you would lose out on £50 of your original contribution – scaled up for an account holding £10,000 including the bonus, this is a £2,500 penalty and a loss of £500 of the original contribution.

Moore said: 'Once participants in the research understood this, there was broad consensus that the current rules feel unfair. 

'Many supported a reduction of the withdrawal charge to 20 per cent, which would at least allow savers to break even if circumstances forced them to dip into their pot.'

'This sentiment was particularly strong among lower-income "irregular" and "cushioned savers", who felt they were being penalised for financial instability rather than poor planning.'

'Savers reported feelings of resentment and frustration at the idea of being charged to access what they saw as their own money, particularly when providers are profiting from holding those funds.'

Houses purchased using a Lisa must also be worth less than £450,000, something that has become a problem for many buyers with house prices having risen considerably since the accounts were introduced.

If the limit had increased with inflation it would now be around £600,000.  

Moore added: 'People are much more likely to understand the product if it has one clear purpose: to get on the housing ladder. 

'To improve transparency and engagement, we believe the Government should simplify the product and rebrand it as a "First Home Account".'