How to set your Lifetime ISA investment goals

The Lifetime ISA is a clever way of saving, as the government gives you free money when you pay into the account.

How to invest the money inside the Lifetime ISA depends on how you intend to use proceeds later – namely do you want to buy a house, fund retirement or something else? The goals can require different saving and investment strategies, so it’s important to have a plan from the start. Let’s look at each scenario in more detail.

Saving to buy your first home

1. Goal: Buy in the next three years

The government will top up your Lifetime ISA contributions by 25%, up to a maximum of £1,000 each year. For example, if you contribute £3,000 into your Lifetime ISA in a tax year, you’ll receive an additional £750 for free.

You can withdraw money without penalty if you’re using it towards buying your first home worth up to £450,000 or you’re aged 60 or older. Otherwise, you pay a 25% penalty on withdrawals.

Anyone looking to buy their first home within the next three years might not want to risk putting their Lifetime ISA money into the stock market in case there is a market downturn in the three-year period and your pot hasn’t had time to recover when you come to buy the property.

Investing is for the long-term and many would consider three years too short a period for such a strategy. In this situation, you might prefer to keep the money in cash where you can earn interest. Just be aware of inflation eating into the buying power of that money.

2. Goal: Buy in the next five to 10 years

The average deposit for first-time buyers is £56,000, according to Zoopla, as of July 2024. Saving the maximum of £4,000 per year in a Lifetime ISA plus the Government’s £1,000 annual bonus would mean you have enough money for a deposit of that size in just under nine years, based on 6% annual investment return and assuming 0.75% charges a year. Use AJ Bell’s Lifetime ISA calculator if you want to see what you could get with different contributions and rates of return.

Someone aiming to buy a house within a shorter period, such as six years, would have to either generate a greater return than 6% each year to hit the average deposit figure, or have existing savings to top up the deposit alongside the proceeds of a Lifetime ISA.

If you are investing for a three-to-five-year period, don’t take excessive risks in the hope of achieving high returns. There is a real chance the markets experience a bad patch during that period, based on historical trends, so you mustn’t expect your capital to consistently grow during the investing period.

Unless you’re an expert in stock picking and are an experienced investor, you might prefer to use investment funds than individual shares as these offer diversification and spread your risks around different areas. For example, a multi-asset fund would invest in shares, bonds and other areas, such as property or gold.

Someone who thinks it will take them longer than eight years to invest for a home deposit might consider a slightly higher weighting to stocks and shares than bonds as these have historically generated stronger returns. There is no guarantee that will always be the case though and it depends on the individual’s attitude to how much risk they want to take with their money.

Saving for the final stages of your working life or for retirement

A Lifetime ISA can supplement your pension. It could function as money to help clear your mortgage before you retire or fund all the bills and personal interests in the initial stages of retirement so you can delay dipping into your pension.

Whatever the decision, you have time on your side. You must be aged 18 to 39 to qualify for a Lifetime ISA, which means there are decades ahead before you can access the money without a penalty, unless using it to buy your first home. Penalty-free withdrawals can only happen once you turn 60.

In this scenario, you have a good amount of time in which to keep adding money to your account and let your investments grow in value over the coming years. Note that you can only make contributions and receive the government bonus until you turn 50, but your investments could continue to grow in value beyond that point.

All withdrawals from Lifetime ISAs are free of tax. You also don’t have to pay any tax on capital gains or dividend income generated by the assets inside the Lifetime ISA. This makes the account type appealing for individuals looking to get the most from their money in later life.

In comparison, pensions enjoy tax relief – another form of government bonus – when you put money into your account. You can withdraw 25% of your pension tax-free but the taxman treats the remaining 75% as income and you may be liable to income tax on it.

Building a Lifetime ISA portfolio to access once you turn 60

There are basic rules to portfolio construction. If you’re starting from nothing, consider having a group of investments that form a ‘core’ or the backbone to your portfolio. These should give you diversification. The ‘core’ might be a mixture of funds that contain shares, bonds, cash and potentially property.

Once you’ve got that backbone in place, you can start to think about adding ‘satellite’ holdings, which may be higher risk selections. These could include funds that target certain sectors, themes or smaller sized companies; or they may be geographic-focused funds, such as emerging markets. AJ Bell has a search tool where you can look for funds in specific areas. You might also be interested in AJ Bell’s list of Favourite funds, chosen by our investment specialists based on value for investors, proven management track record, and clear and robust investment process.

Certain investment experts believe a good strategy is to split your portfolio 80% in favour of the core and 20% for the satellite component. Others go further and suggest a balanced investor may wish to have 50% in shares, 35% in fixed interest (i.e., bonds) and 15% in property – but there is no one-size-fits-all asset allocation model.

If you’ve already got a diversified portfolio via your pension, you may wish to be more adventurous with your Lifetime ISA.

Experienced investors with proven stock picking skills can use the wrapper for short-term trading ideas or long-term investing ideas. Others may wish to buy something and forget about it; or at least not worry about day-to-day changes in valuation – it depends on your style and how you plan to use the money once you can access it.