HMRC takes £56million from savers through Lifetime ISA withdrawal penalties

HM Revenue and Customs (HMRC) has taken more than £56million directly from savers through Lifetime ISA withdrawal penalties since 2018, an analysis of Government data has revealed.

A record 129,200 account holders made unauthorised withdrawals during the 2024-25 tax year, up from 99,700 the previous year.

The figures have prompted criticism from the savings industry, with Luke Kosky, of Freetrade, describing the Lifetime ISA as a failed product in need of reform.

Mr Kosky said: "We have a failed product that we desperately need to reinvent, and punishing people for using a product that promised to be beneficial is a terrifying message for those saving for the future."

In total, HMRC has collected more than £315million in Lifetime ISA withdrawal charges since the accounts were launched in 2017, with more than £56million coming directly from savers' own contributions rather than the Government bonus.

The withdrawal charge is applied when a saver takes money from their Lifetime ISA for a reason other than buying their first home, suffering a terminal illness or reaching the age of 60.

HMRC applies a 25 per cent charge to the entire amount being withdrawn, rather than simply reclaiming the Government bonus attached to the account.

The Government bonus is equivalent to 25 per cent of the amount paid into a Lifetime ISA, meaning a £4,000 contribution receives a £1,000 top-up and creates a total balance of £5,000 before any investment growth.

A 25 per cent charge on the full £5,000 balance would therefore amount to £1,250, leaving the saver with £3,750.

This means the saver loses £250 of their original £4,000 contribution, effectively creating a 6.25 per cent penalty on their own deposits.

Tom Selby, of AJ Bell, described the withdrawal charge as "the biggest flaw in the product design". He said the issue could be addressed by reducing the overall withdrawal charge from 25 per cent to 20 per cent.

Mr Selby said: "Frustratingly, it could be easily fixed by reducing the overall withdrawal charge from 25 per cent to 20 per cent.

"The fact this penalty is netting the Treasury a tidy sum every year is undoubtedly a factor in their belligerence on this issue."

The £315million collected in withdrawal charges since the Lifetime ISA was introduced represents a significant amount of revenue for the Exchequer.

The Lifetime ISA was introduced by former Chancellor George Osborne in 2017, with savers able to contribute up to £4,000 each tax year.

The Government adds a 25 per cent bonus to contributions, meaning savers can receive up to £1,000 a year in Government support if they pay in the maximum amount.

It can be used towards the purchase of a first home costing up to £450,000, or withdrawn without the charge once the saver reaches the age of 60.

The £450,000 property price limit has remained unchanged since the Lifetime ISA was introduced in 2017.

The freeze has raised concerns over the number of properties available to savers using the accounts, particularly in London and the South East where average house prices can be significantly higher than the threshold.

Around 1.6 million Lifetime ISA accounts are currently active across the UK.

The accounts are available to people aged between 18 and 39, while Government bonuses can continue to be paid until the account holder reaches the age of 50.

Savers who withdraw money for other purposes can therefore face the 25 per cent charge, unless they meet one of the specific conditions allowing penalty-free access.

The rules have faced renewed scrutiny as the Government considers changes to the Lifetime ISA system.

Labour has launched a consultation on a streamlined replacement known as the "First-Time Buyer" ISA.

Under the proposed system, the Government bonus would only be paid when the buyer exchanges contracts on their property.

This would mean savers would not receive the bonus at the point they make contributions, potentially removing the opportunity to earn interest or investment returns on the Government top-up before the property purchase.

Proposed changes have attracted scepticism from some in the savings industry, with concerns over how the new system would operate and whether it would provide the same incentives for first-time buyers to build up a deposit.

Figures show that Lifetime ISA savers continue to withdraw money despite the financial penalty attached to doing so.

The number of unauthorised withdrawals reached 129,200 in the 2024-25 tax year, representing a rise of almost 30,000 accounts compared with the previous year.

This increase has placed further focus on whether the existing withdrawal rules adequately reflect the circumstances of people who need to access their savings before they reach 60 or purchase their first home.