What’s better - a Lifetime ISA or hoping for a crash in property prices?
Category: Thought for the day
Thinking of saving up for a home, thinking of helping your children buy a home. Is a Lifetime ISA the answer?
It all boils down to two words: it depends.
Is a Lifetime ISA a good idea if you are trying to save up for a deposit? Answer: under certain conditions, yes.
If you are a parent, maybe you consider yourself a custodian of that most venerable of institutions: The Bank of Mum and Dad – which differs from most banks in that it does not tend to make a profit for the lender – then maybe a Lifetime ISA is the answer, after all, youngsters don’t tend to think about saving, so it may be better to do it on their behalf.
But you need to be aware of the rules. For some, these rules mean it is not the right approach.
The big advantages
There are several big advantages.
First off, is the bonus. For every pound that you put into a Lifetime ISA, there is a 20 pence bonus, paid by the government.
Advantage number two, there is no tax payable on dividends or growth – although that same advantage applies to any other form of ISA.
Advantage number three; there is a 25 per cent penalty if you withdraw from the Lifetime ISA, other than to help buy a property or to fund retirement. Now I know that some might say this is a disadvantage, but there are two reasons why this penalty is an advantage. Firstly, it limits the temptation to withdraw early. Secondly, well before I explain this let me make it clear, if you're over 40, already own a property or have owned a property, then you can’t set up a Lifetime ISA in your name. It has to be in the name of the young person, meaning there is a risk that they may withdraw the money at any moment. So the penalty acts a disincentive to do this, increasing the chances that the money you diligently save on behalf of your offspring is used in the way you intended.
But you also need to beware of the limitations.
For one thing, there is a £4,000 a year limit – with bonus taking it up to £5,000 a year. The bonus is limited to £32,000.
For another, and to reiterate from above, a Lifetime ISA only applies to first time buyers or people over 18 and under 40.
You can’t use a Lifetime ISA to buy a house in conjunction with a ‘help to buy ISA’, although you can transfer your Help to Buy ISA into a Lifetime ISA.
Finally, the home you buy using a Lifetime ISA must cost no more than £450,000. But presumably, this limit will go up over time. That limit may seem like a lot, but if you are looking to buy in London, that money won’t go far. Furthermore, that limit applies even if you are buying in conjunction with someone else.
The time frame
The time frame matters.
As a general rule of thumb, equity investment does not make sense if you are looking to cash in within a few years.
So, let’s say you are targeting saving £15,000 to add to other savings, to put down as a deposit on a house. With bonuses, that would take three years. I would say that a three-year time horizon is rather short for equity investing.
If you are looking to save for 32 years, making full use of the bonuses, then equity investing would indeed make sense – such an approach might make sense if you are saving from the time your child or grandchild turns 18.
Of course, if the idea is to save for retirement – then this is a wholly different issue.
I know many say that a conventional pension policy scores over a Lifetime ISA, but I think such criticism overlooks how the regulator wraps the pension industry in a straight-jacket, sucking fun out of investing, and thus making the public less interested in their investments.
The race against house prices
Some might say that since house prices often rise faster than the rate of inflation, then saving for a property is a mugs game – the value of properties rise faster than you can accumulate savings, especially if your time horizon for buying a property is quite long.
But this is where equity investing comes into its own. If you compare house price inflation with equities, then over time, equities tend to perform better. The FTSE 100 was founded in 1984. Since then it has risen by just over 710 per cent, house prices are up by around 690 per cent. But this superior performance comes despite the fact that this century, so far, has favoured house prices – since low interest rates have supported house prices but the 21st century has seen two major stock market crashes. Add to the equation the dividends you get from equities, I would say that if you are using a Lifetime ISA to save up for a home, either for yourself or your kids/grandkids, then, the longer the time horizon, the more using a Lifetime ISA to invest in equities comes into its own.
Future of house prices
But I cannot leave this article without a word about house prices.
The consensus that house prices can only go up is in my view too complacent. I think the shortage of property argument is also overstated – there is lots of spare capacity in the UK, it is just that around six million people live in homes with two or more spare bedrooms, and they will downsize eventually.
The is also some interesting technology that is making it easier to build homes – by mass producing them off site, and also take a look at Yo Home as an example of how space does not have to be the limiting factor many think it is.