Tax-free ISAs: Rachel Reeves warned 'fundamental rethink' needed as savers hit with £10,600 penalties when taking out own money

Savers withdrawing funds from their Lifetime ISAs face crippling financial penalties, with new data revealing the scale of charges imposed on those accessing their own money.

Freedom of Information figures obtained by GB News show the most severe cases involved average penalties of £10,600 on withdrawals of £42,300.

Nearly 1,000 individuals were charged precisely £1,000 for early withdrawals, whilst 130 faced £2,000 penalties. More than 1,300 savers incurred charges of £5,000 or above.

The punitive withdrawal system means savers forfeit not only the Government bonus but also portions of their original contributions.

Rachel Reeves has been warned that the Lifetime ISA requires a "fundamental rethink" to meet people’s savings goals, rather than leaving them penalised or confused.

HMRC's own data shows 86 per cent of those making unauthorised withdrawals knew they would lose both the bonus and some of their own savings, but did so anyway - highlighting "how desperate people were for access".

The data also shows that 42 per cent of those not currently holding a LISA said a change to the rules so that original savings would not be lost with the withdrawal charge would be most likely to motivate them to open one.

Rachael Griffin, tax and financial planning expert at Quilter said: "The withdrawal penalty continues to punish savers even when they are facing financial strain.

"Many people have faced the difficult battle over the need to save for the future versus the need to pay their bills in recent years, and higher costs have often won.

"This has forced them to stomach the 25 per cent charge to gain access to their money – not only wiping out the Government bonus, but some of their own hard-earned savings too."

The Lifetime ISA launched in April 2017, allowing individuals aged 18 to 39 to save towards their first home or retirement with Government support.

Account holders can contribute up to £4,000 annually until age 50, receiving a 25 per cent Government top-up worth a maximum £1,000 per year. Multiple LISAs can be held simultaneously, though contributions are restricted to one account per tax year.

Funds can be withdrawn without penalty for three specific purposes: purchasing a first home after 12 months, provided the property costs under £450,000 and involves a mortgage and solicitor; accessing money after turning 60 from April 2037; or following a terminal illness diagnosis.

Any withdrawal outside these circumstances incurs a 25 per cent charge on the total balance, including bonuses, resulting in losses beyond the Government contribution.

There have also been many cases where prospective homebuyers found themselves unable to use their LISA funds effectively, particularly when properties exceeded the £450,000 threshold by small amounts.

The £450,000 house price cap has not changed since the product was launched in 2017, despite surging house prices - particularly in London and the South East.

Research found just over half (52 per cent) of those who opened a LISA to buy their first home believed the cap was high enough, while a third (34 per cent) disagreed. That figure rose sharply to 68 per cent among London buyers, and 48 per cent in the South East.

Ms Griffin said: "Put simply, the £450,000 property price cap no longer deals with the reality of the ever more expensive housing market.

"Many who have saved diligently find they cannot use their LISA for the property they need without facing a financial penalty. This undermines confidence in the product and adds to its complexity."

She also highlighted how the rules can work against savers during the buying process.

"There have been numerous anecdotes of home buyers being constantly outbid by small sums over the threshold as the other interested party knows that by doing so the other buyer loses their ability to use their LISA, effectively tying their hands," she explained.

Concerns have also been raised about who the scheme actually supports.

Ms Griffin added: "The profile of LISA holders also raises questions. Nearly half sit in the higher or additional rate tax bands, and most live in London and the South East. This is far from a universally accessible savings vehicle and risks benefitting those already more financially secure."

She concluded: "Taken together, these findings underline why the LISA should be central to the Treasury’s upcoming ISA consultation. Small tweaks won’t be enough.

"A fundamental rethink is needed to create simpler, clearer products that genuinely meet people’s savings goals, rather than leaving them penalised or confused."