Implications of withdrawing from a Lifetime ISA

w00519773

I opened a Lifetime ISA when I was 39 (in 2021).  I bought my house in 2014 so I am using the ISA to save for my pension.

I spoke to Hargreaves Lansdowne today (the ISA provider) and I am confused about the implications of withdrawing from a LISA for invalid reasons i.e. before I am of pension age.

To explain, let's assume I am 39 now and I opened a Lifetime ISA today and contributed £4000 (the maximum).  The government would contribute $1000 (25%), so the LISA would be worth £5000 (lets assume it is cash with no interest rather than stocks so the value does not change).  Say in the next tax year I decided I needed to withdraw £1000 (to pay bills), then as I am not at pension age and not buying my first home, then I assumed my LISA would be worth £3,750 i.e.:

5000-1000-((25/100)*1000)=3,750

However, the way HL explained it - my LISA would be worth £2,750 (because the tax deduction is calculated against the total amount of the LISA (£5,000) rather than the withdrawal i.e.:

5000-1000-((25/100)*5000)=2,750

If I invested £4000 in a LISA today (and left it as cash with no interest) and withdrew £1000 in the next tax year e.g. in October 2024 then would my LISA be worth £3750, £2750 or some other amount after the withdrawal? 

eskbanker

Sounds like crossed wires - their explanation (or your understanding of it) is wrong and yours is right (other than the fact that it's a withdrawal penalty not a 'tax deduction')!  The 25% penalty is applied to the amount withdrawn, not the residual balance:

Any amount withdrawn from a Lifetime ISA that is not the result of a life event is subject to a 25% withdrawal charge. You should deduct this from the funds withdrawn by the investor.

https://www.gov.uk/guidance/lifetime-isa-withdrawal-charges-and-charge-free-withdrawals#when-you-need-to-make-a-withdrawal-charge

w00519773 said:

If I invested £4000 in a LISA today (and left it as cash with no interest) and withdrew £1000 in the next tax year e.g. in October 2024 then would my LISA be worth £3750, £2750 or some other amount after the withdrawal? 

If you withdrew £1000, that would leave £4000 in the account but you'd only have received £750 of that £1000.  Or if you wanted £1000 after the withdrawal penalty, then you'd need to withdraw £1333, leaving £3667.

w00519773

eskbanker said:

Sounds like crossed wires - their explanation (or your understanding of it) is wrong and yours is right (other than the fact that it's a withdrawal penalty not a 'tax deduction')!  The 25% penalty is applied to the amount withdrawn, not the residual balance:

Any amount withdrawn from a Lifetime ISA that is not the result of a life event is subject to a 25% withdrawal charge. You should deduct this from the funds withdrawn by the investor.

https://www.gov.uk/guidance/lifetime-isa-withdrawal-charges-and-charge-free-withdrawals#when-you-need-to-make-a-withdrawal-charge

w00519773 said:

If I invested £4000 in a LISA today (and left it as cash with no interest) and withdrew £1000 in the next tax year e.g. in October 2024 then would my LISA be worth £3750, £2750 or some other amount after the withdrawal? 

If you withdrew £1000, that would leave £4000 in the account but you'd only have received £750 of that £1000.  Or if you wanted £1000 after the withdrawal penalty, then you'd need to withdraw £1333, leaving £3667.

Thanks.  So if I withdrew £1,000 i.e. £1,000 was transferred to my bank account, then my ISA would reduce by £1,333? i.e. it would effectively cost £333?

That doesn't make sense to me because £333 is 33.3% of £1,000 and not 25%?

masonic

w00519773 said:

eskbanker said:

Sounds like crossed wires - their explanation (or your understanding of it) is wrong and yours is right (other than the fact that it's a withdrawal penalty not a 'tax deduction')!  The 25% penalty is applied to the amount withdrawn, not the residual balance:

Any amount withdrawn from a Lifetime ISA that is not the result of a life event is subject to a 25% withdrawal charge. You should deduct this from the funds withdrawn by the investor.

https://www.gov.uk/guidance/lifetime-isa-withdrawal-charges-and-charge-free-withdrawals#when-you-need-to-make-a-withdrawal-charge

w00519773 said:

If I invested £4000 in a LISA today (and left it as cash with no interest) and withdrew £1000 in the next tax year e.g. in October 2024 then would my LISA be worth £3750, £2750 or some other amount after the withdrawal? 

If you withdrew £1000, that would leave £4000 in the account but you'd only have received £750 of that £1000.  Or if you wanted £1000 after the withdrawal penalty, then you'd need to withdraw £1333, leaving £3667.

Thanks.  So if I withdrew £1,000 i.e. £1,000 was transferred to my bank account, then my ISA would reduce by £1,333? i.e. it would effectively cost £333?

That doesn't make sense to me because £333 is 33.3% of £1,000 and not 25%?

£333 is about 25% of £1,333, which is the amount you would be withdrawing (this is equivalent to £1,000 capital plus return of Government bonus of £250 + £83 net penalty). 

If you withdraw £1000, then you'd end up with £750 in your bank account and pay a £250 penalty. This would consist of £800 capital, £200 return of Government bonus and £50 net penalty.

The penalty is calculated on the gross amount withdrawn from your balance.

NoMore

w00519773 said:

Thanks.  So if I withdrew £1,000 i.e. £1,000 was transferred to my bank account, then my ISA would reduce by £1,333? i.e. it would effectively cost £333?

That doesn't make sense to me because £333 is 33.3% of £1,000 and not 25%?

But its 25% of the total withdrawal (25% * 1333) which is correct as that's how the calculation is done, why would you assume it would be 25% of the amount you are left with ?. I assume eskbanker has just rounded to the nearest pound.

w00519773

masonic said:

w00519773 said:

eskbanker said:

Sounds like crossed wires - their explanation (or your understanding of it) is wrong and yours is right (other than the fact that it's a withdrawal penalty not a 'tax deduction')!  The 25% penalty is applied to the amount withdrawn, not the residual balance:

Any amount withdrawn from a Lifetime ISA that is not the result of a life event is subject to a 25% withdrawal charge. You should deduct this from the funds withdrawn by the investor.

https://www.gov.uk/guidance/lifetime-isa-withdrawal-charges-and-charge-free-withdrawals#when-you-need-to-make-a-withdrawal-charge

w00519773 said:

If I invested £4000 in a LISA today (and left it as cash with no interest) and withdrew £1000 in the next tax year e.g. in October 2024 then would my LISA be worth £3750, £2750 or some other amount after the withdrawal? 

If you withdrew £1000, that would leave £4000 in the account but you'd only have received £750 of that £1000.  Or if you wanted £1000 after the withdrawal penalty, then you'd need to withdraw £1333, leaving £3667.

Thanks.  So if I withdrew £1,000 i.e. £1,000 was transferred to my bank account, then my ISA would reduce by £1,333? i.e. it would effectively cost £333?

That doesn't make sense to me because £333 is 33.3% of £1,000 and not 25%?

£333 is about 25% of £1,333, which is the amount you would be withdrawing (this is equivalent to £1,000 capital plus return of Government bonus of £250 + £83 net penalty). 

If you withdraw £1000, then you'd end up with £750 in your bank account and pay a £250 penalty. This would consist of £800 capital, £200 return of Government bonus and £50 net penalty.

The penalty is calculated on the gross amount withdrawn from your balance.

Thanks.  It was not aware of the £83 net penalty.  Is this penalty imposed for every withdrawal and is it always £83 across providers?

ColdIron

w00519773 said:

masonic said:

w00519773 said:

eskbanker said:

Sounds like crossed wires - their explanation (or your understanding of it) is wrong and yours is right (other than the fact that it's a withdrawal penalty not a 'tax deduction')!  The 25% penalty is applied to the amount withdrawn, not the residual balance:

Any amount withdrawn from a Lifetime ISA that is not the result of a life event is subject to a 25% withdrawal charge. You should deduct this from the funds withdrawn by the investor.

https://www.gov.uk/guidance/lifetime-isa-withdrawal-charges-and-charge-free-withdrawals#when-you-need-to-make-a-withdrawal-charge

w00519773 said:

If I invested £4000 in a LISA today (and left it as cash with no interest) and withdrew £1000 in the next tax year e.g. in October 2024 then would my LISA be worth £3750, £2750 or some other amount after the withdrawal? 

If you withdrew £1000, that would leave £4000 in the account but you'd only have received £750 of that £1000.  Or if you wanted £1000 after the withdrawal penalty, then you'd need to withdraw £1333, leaving £3667.

Thanks.  So if I withdrew £1,000 i.e. £1,000 was transferred to my bank account, then my ISA would reduce by £1,333? i.e. it would effectively cost £333?

That doesn't make sense to me because £333 is 33.3% of £1,000 and not 25%?

£333 is about 25% of £1,333, which is the amount you would be withdrawing (this is equivalent to £1,000 capital plus return of Government bonus of £250 + £83 net penalty). 

If you withdraw £1000, then you'd end up with £750 in your bank account and pay a £250 penalty. This would consist of £800 capital, £200 return of Government bonus and £50 net penalty.

The penalty is calculated on the gross amount withdrawn from your balance.

Thanks.  It was not aware of the £83 net penalty.  Is this penalty imposed for every withdrawal and is it always £83 across providers?

No. There is no universal '£83 net penalty'. It's just the arithmetic in that example

If you had to pay a £1,000 bill and withdrew £1,000 you'd only get £750 (after the 25% penalty) in your bank and be £250 short for your bill

If you wanted to get £1,000 in your bank account to pay that bill you'd need to withdraw £1,333 to get £1,000 (after the 25% penalty)

masonic was just breaking it down further to highlight how much you'd be down on the deal, that net penalty, the cost to you on the round trip if you like

eskbanker

w00519773 said:

Thanks.  It was not aware of the £83 net penalty.  Is this penalty imposed for every withdrawal and is it always £83 across providers?

It's not a fixed amount, but is 6.25% of the amount of the gross withdrawal that relates to the original deposit, i.e. if you pay in £1000, that's boosted to £1250 by the 25% government bonus, but the 25% deduction applied to a withdrawal of that £1250 not only reverses the £250 bonus element but also another £62.50.

Withdrawal penalties are imposed for every withdrawal before you reach 60, unless they're for a qualifying first time property purchase.

w00519773

eskbanker said:

w00519773 said:

Thanks.  It was not aware of the £83 net penalty.  Is this penalty imposed for every withdrawal and is it always £83 across providers?

It's not a fixed amount, but is 6.25% of the amount of the gross withdrawal that relates to the original deposit, i.e. if you pay in £1000, that's boosted to £1250 by the 25% government bonus, but the 25% deduction applied to a withdrawal of that £1250 not only reverses the £250 bonus element but also another £62.50.

Withdrawal penalties are imposed for every withdrawal before you reach 60, unless they're for a qualifying first time property purchase.

So if I make a withdrawal of £1,000 then my plan reduces by:

1) £1000 +
2) 25% of £1000 +
3) 6.25% of £1000

Therefore it costs £62.50 more to withdraw £1000 than it costed to invest.  Why is there a 6.25% penalty - is that accross all providers? Is it just a deterrent to withdraw?

masonic

w00519773 said:

So if I make a withdrawal of £1,000 then my plan reduces by:

1) £1000 +
2) 25% of £1000 +
3) 6.25% of £1000

Therefore it costs £62.50 more to withdraw £1000 than it costed to invest.  Why is there a 6.25% penalty - is that accross all providers? Is it just a deterrent to withdraw?

If you withdraw £1000, your plan reduces by £1000, then the 25% penalty is applied, and you receive £750. It only costed you £800 to invest £1000, because the Government topped up the £800 by 25%, adding on £200.

Yes, these are Government rules and it was intentional that there should be a 6.25% net penalty to withdrawing for a reason other than a first time property purchase or retirement. During Covid, they reduced the penalty so that you got out what you put in (+ any interest), then raised it again afterwards.