Lifetime ISA to be SCRAPPED in Budget small print after savers charged £13,500 when taking out own money

The Budget said: "The government will publish a consultation in early 2026 on the implementation of a new, simpler Isa product to support first time buyers to buy a home.

"Once available, this new product will be offered in place of the lifetime Isa."

Budget documents revealed the plans after withdrawal penalties hit a record £102million in the last tax year, with 129,200 savers incurring charges for accessing their funds outside permitted circumstances.

The proposed changes affect 1.6 million active account holders who currently use the dual-purpose savings vehicle for either property purchases or retirement planning.

Rachael Griffin, tax and financial planning expert at Quilter, said: "At long last, the government has conceded that the Lifetime ISA is a confused product in desperate need of simplification."

The consultation aims to create a simpler product focused solely on helping first-time buyers get onto the property ladder.

Recent HMRC figures show a sharp rise in penalties for Lifetime Isa withdrawals, with the average penalty among the 25 largest charges increasing to £13,500 in 2024–25, up from £10,600 the year before.

Although 87,000 people were able to use their savings to buy a home, many others faced heavy charges for taking money out for other reasons.

The typical penalty was £790, but the amount varied widely depending on the size of the savings pot.

Savers are hit with a 25 per cent charge on their full balance if they withdraw their money outside of the permitted conditions: buying a first home, turning 60, or being diagnosed with a terminal illness.

This penalty system doesn’t just remove the government’s 25 per cent bonus — it also takes some of the saver’s own money.

Since its launch in 2017, the Lifetime ISA has struggled to fulfil its dual purpose of supporting both first-time buyers and retirement savers.

Ms Griffin noted that the £450,000 property price limit has remained unchanged since the product was introduced, creating particular problems for buyers in London and the South East who cannot purchase a suitable home without triggering penalties.

"This has undermined confidence in the product and added complexity and must be addressed within the new product," she noted.

The withdrawal penalty system has drawn criticism for its severity, as it reclaims more than just the government bonus when savers access funds during financial hardship.

Annual contribution limits will remain at £4,000 until 2031, though the product's eventual replacement signals a shift towards single-purpose savings vehicles.

Self-employed workers who rely on the Lifetime ISA for retirement planning face particular uncertainty from the proposed changes.

Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, warned: "Today's announcement on the Lifetime ISA will be worrying for those who rely on it for their retirement savings."

She explained that self-employed individuals are excluded from auto-enrolment schemes and therefore miss employer pension contributions, while traditional pensions prevent access before age 55.

The LISA bonus mirrors basic-rate tax relief on pensions, with tax-free income available after 60 and emergency access possible despite exit charges.

"The consultation into a replacement must consider the needs of self-employed people saving for retirement. They are already under-saving, so it's important not to put any more barriers in the way," Morrissey added.

Financial services firms are urging the government to protect existing savers during the transition to any new product.

Sarah Coles, head of personal finance at Hargreaves Lansdown, emphasised: "The right consultation on its replacement is vital, and needs to ensure that dedicated savers and investors, who have been putting money away for their first property or for retirement aren't disadvantaged by any change."

Maike Currie from PensionBee suggested the reforms send a clear signal that "pensions remain the UK's only durable, purpose-built long-term savings product."

She advised retirement savers to establish personal pensions, noting that "pensions offer the stability, tax relief and regulatory protection that ISAs cannot match."

The consultation process will need to address how current account holders transition to new arrangements without losing accumulated benefits.